Taxation of Company Reorganisations 9781526511492, 9781526511522, 9781526511515

Taxation of Company Reorganisations, Sixth Edition is an essential reference source for tax advisers which covers the ba

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Table of contents :
Preface
Authors
Contents
Table of statutes
Table of statutory instruments
Table of cases
Part 1. Fundamentals of corporation tax
Chapter 1: Corporation tax and chargeable gains
Introduction
Corporation tax
Taxation of capital gains
Conclusion
Basic rules of corporation tax
Taxation of capital gains
Group relationship rules
The degrouping charge
Substantial shareholding exemption
Taxation of intangible fixed assets
Taxation of loan relationships
Taxation of derivative contracts
Tax avoidance and anti-avoidance
Conclusion
Chapter 2: Stamp taxes
A brief history
Stamp duty and SDRT
Consideration
Reliefs
SDLT
Anti-avoidance
LBTT
Anti-avoidance
LTT
Anti-avoidance
Chapter 3: Value added tax
The VAT system in outline
VAT and company reorganisations
Chapter 4: EU legislation
Scope of this chapter
Introduction to EU legislation
Mergers of public limited liability companies
Divisions of public limited liability companies
The Mergers Directive
Cross-border mergers
The Sevic case
The European Company Statute
Societas Europaea
What does the future hold?
Conclusion
Part 2. Reorganisations
Chapter 5: Introduction to reorganisations
Introduction
Meaning of 'reorganisation' – the plain English approach
Early tax legislation
The meaning of 'reorganisation' – case law
Purpose of the legislation
Achieving Parliament's intention
Conclusion
Chapter 6: Reorganisations of share capital
Introduction
The legislation
Examples
Capital reductions and their interaction with distributions
Conclusion
Stamp taxes and reorganisations
Value added tax
Chapter 7: Conversions of securities
Introduction
Definition of 'security'
The legislation
Conclusion
Stamp taxes
Value added tax
Part 3. Deemed reorganisations
Chapter 8: Share-for-share exchanges
Introduction to Part 3
Purpose of the legislation
Introduction
The legislation
Examples
Interaction with capital gains degrouping charge
Conclusion
Stamp taxes
Value added tax
Chapter 9: Exchanges involving qualifying corporate bonds
Introduction
What is a QCB?
How to make a non-QCB
The legislation
Examples
Conclusion
Stamp taxes
Value added tax
Chapter 10: Earn-outs
Introduction
The legislation
Examples
Conclusion
Stamp taxes
Value added tax
Chapter 11: Interaction with substantial shareholding exemption
Introduction
Share-for-share exchanges – internal reorganisations
Share-for-share exchanges – disposals
Reorganisations involving QCBs
Simple reorganisations
Conclusion
Flow chart
Chapter 12: Interactions with other legislation
Reliefs designed to encourage investment
Conclusion
Chapter 13: Reorganisations: Anti-avoidance and clearances
Introduction
The legislation
Conclusion
Chapter 14: Clearances
Introduction
The legislation
Practical issues
Other tax regimes
Conclusion
Stamp taxes
Value added tax
Part 4. Reconstructions
Chapter 15: Introduction to reconstructions
Introduction
Meaning of ‘reconstruction’ – the plain English approach
Company law decisions
Early tax legislation
What is a reconstruction?
Non-statutory tax practices
Modern tax legislation
Conclusion
Stamp taxes and VAT
Chapter 16: Definition of ‘reconstruction’
Introduction
Overview of the definition
The definition – TCGA 1992, Sch 5AA
Conclusion
Chapter 17: Company compromises or arrangements
Introduction
CA 2006, ss 895 and 899 – application and court sanction for compromise or arrangement
CA 2006, s 900 – powers of court to facilitate reconstruction or amalgamation
Conclusion
Value added tax
Stamp taxes
Chapter 18: The UK reconstruction reliefs
Introduction
TCGA 1992, s 136 – shareholder and creditor reconstruction relief
TCGA 1992, s 136 – scheme of reconstruction involving issue of securities
TCGA 1992, s 139 – company reconstruction relief
TCGA 1992, s 139 – reconstruction involving transfer of business
Reconstructions and intangible fixed assets – CTA 2009, Part 8
Interaction of CTA 2009, Part 8 with chargeable gains provisions
Conclusion
Stamp taxes
Value added tax
Part 5. Mergers
Chapter 19: UK company mergers
Scope of this chapter
Legal considerations
Merger structures
Commercial transactions
Tax analysis
Is it a reconstruction?
Reliefs for transferor companies
Is it a distribution?
Capital gains reliefs for non-corporate shareholders
Capital gains reliefs for corporate shareholders
Upstream mergers: a special case
Further issues relating to mergers
Conclusion
Stamp taxes
Value added tax
Chapter 20: Cross-border mergers
Introduction
Definitions of a merger
Legal background
FA 2007, s 110 Mergers Directive regulations
The UK regulations
The legislation
TCGA 1992, s 140E: mergers leaving assets within UK tax charge
Further reliefs for mergers that leave assets within the UK tax charge
Intangible fixed assets – European cross-border merger: transfer of UK business
Loan relationships: European cross-border merger
Derivative contracts: European cross-border merger
Mergers leaving assets outside the UK tax charge
Further reliefs for mergers that leave assets outside the UK tax charge
Treatment of securities issued on merger – shareholder relief
Distributions
Other consequential provisions
Conclusion
Stamp taxes
Value added tax
Part 6. Demergers
Chapter 21: Introduction to demergers
Introduction
What is a demerger?
Why demerge?
Conclusion
Chapter 22: Demergers: legal background
The legal basis for a demerger
Dissolution without winding up
Interaction with EU legislation
Demerger structures
Direct demergers
Stamp taxes and direct demergers
Indirect demergers
Stamp taxes and indirect demergers
Chapter 23: Liquidation distributions
Introduction and commercial purpose
Legal background
Tax analysis
Commercial issues on liquidation demergers
Conclusion
Liquidation demergers and stamp taxes
Value added tax
Chapter 24: Exempt distributions
Historical introduction and commercial purpose
Legal background
Overview of the code
Structure of the code
Examples and analyses
Conclusion
Stamp taxes and distribution demergers
Value added tax
Chapter 25: 'Return of capital' demergers
Introduction and commercial purpose
Legal background
Tax analysis
Conclusion
Stamp duty
Stamp duty land tax
Value added tax
Chapter 26: EU cross-border demergers
Introduction
Legislative background
EU cross-border demerger transactions
Specific legislation for the Mergers Directive
Further reliefs for cross-border demergers
Interaction with overseas equivalents to Mergers Directive provisions
UK equivalents to Mergers Directive divisions
Conclusion – legislation arising from the EU Mergers Directive
Stamp taxes
Value added tax
Part 7. Branch incorporations
Chapter 27: Incorporation of non-UK branches
Introduction
Foreign permanent establishment exemption
The legislation
Conclusion
Stamp taxes
Value added tax
Chapter 28: EU branch incorporations
Introduction
Transfers of assets
The legislation
Further reliefs for cross-border demergers
Conclusion – branch incorporations
Stamp taxes
Value added tax
Index

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Taxation of Company Reorganisations
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George Hardy
Fehzaan Ismail
Steven Bone
David Hannah
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Andrew Needham
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Taxation of Company Reorganisations Sixth Edition

ii

Taxation of Company Reorganisations

Sixth Edition Pete Miller CTA (Fellow), The Miller Partnership George Hardy PhD, MA (Cantab), Ernst & Young Fehzaan Ismail BSc (Hons), CA, CTA, Ernst & Young

with Steven Bone BSc (Hons), PGDip.BA, FRICS, ATT, Gateley Capitus David Hannah ACA, CTA, Consultant, Cornerstone Tax Ltd Sarah Holmes MA (Cantab), Solicitor, Ernst & Young Andrew Needham BA, CTA,VAT Specialists Limited Andrew Rainford BA (Hons), CTA, ATT

BLOOMSBURY PROFESSIONAL Bloomsbury Publishing Plc 41–43 Boltro Road, Haywards Heath, RH16 1BJ, UK BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc © Bloomsbury Professional Ltd 2020 All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. While every care has been taken to ensure the accuracy of this work, no responsibility for loss or damage occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the authors, editors or publishers. The views expressed by the authors are not intended to be a substitute for formal advice. All UK Government legislation and other public sector information used in the work is Crown Copyright ©. All House of Lords and House of Commons information used in the work is Parliamentary Copyright ©. This information is reused under the terms of the Open Government Licence v3.0 (http://www.nationalarchives.gov.uk/ doc/open-government-licence/version/3) except where otherwise stated. All Eur-lex material used in the work is © European Union, http://eur-lex.europa.eu/, 1998–2020. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. ISBN: PB: 978 1 52651 149 2 ePDF: 978 1 52651 151 5 ePub: 978 1 52651 150 8 Typeset by Compuscript Ltd, Shannon To find out more about our authors and books, visit www.bloomsburyprofessional.com. Here you will find extracts, author information, details of forthcoming events and the option to sign up for our newsletters.

Preface WHAT HAS CHANGED? The fifth edition was published in 2016, nearly four years ago. There have been few fundamental changes to the tax legislation relating to reorganisations and reconstructions in that period, but there have been four Finance Acts, tax devolution to Wales and Northern Ireland, LBTT developments in Scotland, and a number of new decided cases. We have also added new material on taxadvantaged investments and on capital allowances.

THANKS Once again, we have brought some new authors on board. Their details are on the next page but we would like to thank Fehzaan Ismail (Fez), who has joined as a core author and has brought an entirely new viewpoint to the contents, as well as our new subject matter experts, David Hannah (stamp taxes), Andrew Needham (VAT), Andrew Rainford (tax-advantaged investment schemes), Sarah Holmes (assisted by Mark Hardy) (legal) and Steven Bone (capital allowances). Their help, support and enthusiasm for this project has been very much appreciated. As always, several people have helped, encouraged and supported us during the writing of the sixth edition. We would like to thank our wives, Tracey Miller, Marie-Thérèse Hardy and Aaminah Ismail, for their support and understanding. Fez would also like to thank his parents, Farid and Razia Ismail. Dave Wright and Claire McDermott at Bloomsbury Professional have encouraged, persuaded, cajoled and occasionally despaired during the gestation of this edition. Thank you, Dave and Claire, for all of the above, for your patience and forbearance, and for a really great lunch during which you persuaded us to do this all over again! George would like to thank EY for allowing him the freedom to continue writing and updating this book. Pete does not have to rely on the tolerance of an employer but would nevertheless like to thank all of his clients and professional colleagues who have encouraged him to continue his involvement with the book on the basis that they find it an exceptionally useful practical guide for use in their day-to-day work. A number of people have commented, for example, that a copy of the book is constantly on their desks, and there have been many emails since the announcement of the new edition asking when it was eventually going to be published.

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Preface Indeed, we would like to thank the many people who have said or written some extremely complimentary things about earlier editions, whether in public or in private. The appreciation of our professional colleagues and friends is the highest possible praise for our efforts and we hope that this edition is as well received. As always, we would like to acknowledge our debt to all those authors who have gone before us and have written books or articles or other material that have in one way or another contributed to the sum of our knowledge and understanding of the UK tax system. And finally, thank you, dear reader, for buying the book.

PLEASE HELP This is a book written by active tax advisers aimed at providing both technical analysis and practical guidance for you, our professional colleagues. We hope that it succeeds in its aims and that you find this book both useful and interesting. To paraphrase an old adage, if you liked it, please tell your friends, and us. If not, please tell us, so that we can do something about it. We are genuinely happy to receive corrections, comments and constructive criticism to help improve future editions, so please direct your comments either to us personally ([email protected], [email protected]. com or [email protected]) or to Bloomsbury Professional, 41–43 Boltro Road, Haywards Heath, West Sussex RH16 1BJ or by email to [email protected]. We would particularly like to record our thanks to the following for their vigilance and for their kind comments about the fifth edition of this book: Richard Sultman of Cleary Gottlieb Steen & Hamilton LLP, Elaine Kinsella of Old Mill Group, Bill Kavanagh of Thompson Wright Chartered Accountants (again!), Henry Male and Robin Staunton of TLT LLP, David Hibbert of Smailes Goldie, Keith Jewitt of UNW LLP and Conor Brindley of Ernst & Young LLP. Pete Miller September 2020

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Authors Pete Miller CTA (Fellow) has over 32 years’ experience in tax, covering all aspects of business and corporation tax issues. Pete founded The Miller Partnership in 2011 to offer expert advice on all business tax issues to other advisers, particularly lawyers and accountants. Specialist areas include reorganisations and reconstructions, the substantial shareholding exemption, the transactions in securities rules, the anti-phoenixing rules, HMRC clearances, taxation of intangible assets and the patent box legislation. George Hardy PhD, MA (Cantab) is a Financial Services Tax Partner at EY and heads up their tax relationship in EMEIA with three global banks, as well as being a senior member of EY’s International Tax and Transaction Services team. With Fehzaan, he has recently been heavily involved in Brexit-related transactions and reorganisations. Fehzaan Ismail BSc (Hons), CA, CTA is a Senior Manager in EY’s International Tax and Transaction Services team and advises clients in the financial services sector. His specialist areas include chargeable gains (including reorganisations and share disposals), loan relationships, foreign PEs and CFCs, hybrid mismatches and intangible fixed assets. Fehzaan has also been heavily involved in the delivery and thought-leadership on the tax issues arising from Brexit and other restructuring transactions. Steven Bone BSc (Hons), PGDip.BA, FRICS, ATT (Fellow) is a director at Gateley Capitus, tax incentives specialists including capital allowances on commercial property, land remediation relief and R&D tax relief. He is a tax-qualified Chartered Surveyor with over 20 years’ experience including opinions, transaction negotiations, specialist valuations, resolving HMRC compliance checks and making tribunal applications. Steven writes many of the published works on property tax incentives: Bloomsbury Professional’s Capital Allowances: Transactions and Planning, the RICS’s Guidance Note for surveyors, and Practical Law Company’s Practice Note on commercial property enquiries dealing with capital allowances. David Hannah ACA, CTA is Principal Consultant at Cornerstone Tax 2020 Ltd. Having spent more than three decades working in property tax, David is regularly quoted in industry and the national press on SDLT matters, as well as providing formal training to solicitors in understanding SDLT and related property taxes. Andrew Needham BA, CTA heads up VAT Specialists Ltd. Andrew has a degree in Law and is a specialist in indirect taxes. Andrew has over 30 years’

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Authors experience in VAT, having worked for HM Customs & Excise, Deloitte & Touche and EY. He is also a specialist in international tax, land and property issues and a lecturer on VAT issues. He was a VAT adviser to the Forum of Private Business and is author of Bloomsbury Professional’s Value Added Tax (previously Tottel’s Value Added Tax). Andrew Rainford BA (Hons), CTA, ATT trained and qualified with an independent London firm of accountants and subsequently worked on EY’s personal tax consultancy team. Now based in North Wales, he is the author of Enterprise Investment Scheme and other Venture Capital Reliefs and runs his own tax consultancy and writing business, Red Dragon Consulting, working directly for private clients and also supporting other tax advisers. Sarah Holmes MA (Cantab), Solicitor, is an Associate Partner with EY’s legal practice specialising in complex international corporate restructuring, business transformation, corporate governance, corporate simplification and singleentity projects, advising multinational clients within a wide range of industries. Navarone Moscher trained and qualified as a solicitor with EY’s Corporate Law practice specialising in complex international corporate reorganisations, business transformation and corporate simplification and advises multinational clients within a wide range of industries. Mark Hardy is a solicitor at EY and has been with the firm for three years, during which time he has worked in its Financial Services, Corporate Structuring and Commercial Law practices. Prior to joining EY, he spent two years in the Investment Management Tax team at PwC. He has an MA (Hons) in Management from the University of St Andrews and the ICAEW Certificate in Finance, Accounting and Business.

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Contents Prefacev Authorsvii Table of statutes xvii Table of statutory instruments xxxi Table of cases xxxiii Part 1: Fundamentals of corporation tax

1

Chapter 1: Corporation tax and chargeable gains 3 Introduction3 Corporation tax 3 Taxation of capital gains 4 Conclusion5 Basic rules of corporation tax 6 Taxation of capital gains 7 Group relationship rules 9 The degrouping charge 11 Substantial shareholding exemption 12 Taxation of intangible fixed assets 24 Taxation of loan relationships 32 Taxation of derivative contracts 40 Tax avoidance and anti-avoidance 46 Conclusion61 Chapter 2: Stamp taxes 62 A brief history 62 Stamp duty and SDRT 63 Consideration66 Reliefs68 SDLT75 Anti-avoidance78 LBTT 80 Anti-avoidance 81 LTT 82 Anti-avoidance 83 Chapter 3: Value added tax The VAT system in outline VAT and company reorganisations

84 84 88

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Contents Chapter 4: EU legislation Scope of this chapter Introduction to EU legislation Mergers of public limited liability companies Divisions of public limited liability companies The Mergers Directive Cross-Border mergers The Sevic case The European Company Statute Societas Europaea What does the future hold? Conclusion

97 97 98 102 107 111 116 116 118 120 126 128

Part 2: Reorganisations

129

Chapter 5: Introduction to reorganisations Introduction Meaning of ‘reorganisation’ – the plain English approach Early tax legislation The meaning of ‘reorganisation’ – case law Purpose of the legislation Achieving Parliament’s intention Conclusion

131 131 131 133 134 139 141 142

Chapter 6: Reorganisations of share capital Introduction The legislation Examples Capital reductions and their interaction with distributions Conclusion Stamp taxes and reorganisations Value added tax

143 143 143 171 178 180 181 182

Chapter 7: Conversions of securities Introduction Definition of ‘security’ The legislation Conclusion Stamp taxes Value added tax

184 184 185 187 199 200 200

Part 3: Deemed reorganisations

201

Chapter 8: Share-for-share exchanges Introduction to Part 3 Purpose of the legislation Introduction

203 203 203 204

x

Contents The legislation Examples Interaction with capital gains degrouping charge Conclusion Stamp taxes Value added tax

204 218 224 225 226 226

Chapter 9: Exchanges involving qualifying corporate bonds Introduction What is a QCB? How to make a non-QCB The legislation Examples Conclusion Stamp taxes Value added tax

236 236 236 237 239 251 253 253 254

Chapter 10: Earn-outs Introduction The legislation Examples Conclusion Stamp taxes Value added tax

255 255 256 265 268 268 270

Chapter 11: Interaction with substantial shareholding exemption 271 Introduction271 Share-for-share exchanges – internal reorganisations 271 Share-for-share exchanges – disposals 274 Reorganisations involving QCBs 275 Simple reorganisations 277 Conclusion278 Flow chart 280 Chapter 12: Interactions with other legislation 281 Reliefs designed to encourage investment 281 Conclusion291 Chapter 13: Reorganisations: Anti-avoidance and clearances 292 Introduction292 The legislation 297 Conclusion307 Chapter 14: Clearances Introduction The legislation

308 308 308 xi

Contents Practical issues Other tax regimes Conclusion Stamp taxes Value added tax

316 318 318 318 319

Part 4: Reconstructions

321

Chapter 15: Introduction to reconstructions 323 Introduction323 Meaning of ‘reconstruction’ – the plain English approach 323 Company law decisions 324 Early tax legislation 328 What is a reconstruction? 333 Non-statutory tax practices 335 Modern tax legislation 338 Conclusion338 Stamp taxes and VAT 339 Chapter 16: Definition of ‘reconstruction’ 340 Introduction340 Overview of the definition 340 The definition – TCGA 1992, Sch 5AA342 Conclusion355 Chapter 17: Company compromises or arrangements 356 Introduction356 CA 2006, ss 895 and 899 – application and court sanction for compromise or arrangement 356 CA 2006, s 900 – powers of court to facilitate reconstruction or amalgamation 360 Conclusion362 Value added tax 363 Stamp taxes 364 Chapter 18: The UK reconstruction reliefs 365 Introduction365 TCGA 1992, s 136 – shareholder and creditor reconstruction relief 365 TCGA 1992, s 136 – scheme of reconstruction involving issue of securities 367 TCGA 1992, s 139 – company reconstruction relief 371 TCGA 1992, s 139 – reconstruction involving transfer of business 373

xii

Contents Reconstructions and intangible fixed assets – CTA 2009, Part 8383 Interaction of CTA 2009, Part 8 with chargeable gains provisions387 Conclusion388 Stamp taxes 388 Value added tax 389 Part 5: Mergers

391

Chapter 19: UK company mergers Scope of this chapter Legal considerations Merger structures Commercial transactions Tax analysis Is it a reconstruction? Reliefs for transferor companies Is it a distribution? Capital gains reliefs for non-corporate shareholders Capital gains reliefs for corporate shareholders Upstream mergers: a special case Further issues relating to mergers Conclusion Stamp taxes Value added tax

393 393 393 399 403 405 405 407 408 411 412 413 413 414 414 414

Chapter 20: Cross-border mergers Introduction Definitions of a merger Legal background FA 2007, s 110 Mergers Directive Regulations The UK Regulations The legislation TCGA 1992, s 140E: mergers leaving assets within UK tax charge Further reliefs for mergers that leave assets within the UK tax charge Intangible fixed assets – European cross-border merger: transfer of UK business Loan relationships: European cross-border merger Derivative contracts: European cross-border merger Mergers leaving assets outside the UK tax charge Further reliefs for mergers that leave assets outside the UK tax charge Treatment of securities issued on merger – shareholder reliefs Distributions

415 415 416 417 418 421 421 422 430

xiii

431 431 432 433 436 437 441

Contents Other consequential provisions Conclusion Stamp taxes Value added tax

442 442 443 443

Part 6: Demergers

445

Chapter 21: Introduction to demergers Introduction What is a demerger? Why demerge? Conclusion

447 447 447 448 451

Chapter 22: Demergers: legal background The legal basis for a demerger Dissolution without winding up Interaction with EU legislation Demerger structures Direct demergers Stamp taxes and direct demergers Indirect demergers Stamp taxes and indirect demergers

452 452 452 454 455 460 464 464 467

Chapter 23: Liquidation distributions 469 Introduction and commercial purpose 469 Legal background 471 Tax analysis 472 Commercial issues on liquidation demergers 481 Conclusion483 Liquidation demergers and stamp taxes 484 Value added tax 485 Chapter 24: Exempt distributions 488 Historical introduction and commercial purpose 488 Legal background 489 Overview of the code 490 Structure of the code 491 Examples and analyses 548 Conclusion560 Stamp taxes and distribution demergers 560 Value added tax 561 Chapter 25: ‘Return of capital’ demergers Introduction and commercial purpose Legal background Tax analysis xiv

564 564 565 578

Contents Conclusion585 Stamp duty 585 Stamp duty land tax 586 Value added tax 588 Chapter 26: EU cross-border demergers 589 Introduction589 Legislative background 590 EU cross-border demerger transactions 593 Specific legislation for the Mergers Directive 602 Further reliefs for cross-border demergers 617 Interaction with overseas equivalents to Mergers Directive provisions 620 UK equivalents to Mergers Directive divisions 621 Conclusion – legislation arising from the EU Mergers Directive 621 Stamp taxes 622 Value added tax 622 Part 7: Branch incorporations

625

Chapter 27: Incorporation of non-UK branches 627 Introduction627 Foreign permanent establishment exemption 627 The legislation 630 Conclusion647 Stamp taxes 647 Value added tax 648 Chapter 28: EU branch incorporations 650 Introduction650 Transfers of assets 651 The legislation 652 Further reliefs for cross-border demergers 665 Conclusion – branch incorporations 668 Stamp taxes 668 Value added tax 669 Index671

xv

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Table of statutes [All references are to paragraph numbers] C Capital Allowances Act 2001 Pt 2 (ss 11–270)�� 1.55 s 11, 15, 61, 62�� 1.55 Pt 2 Ch 14 (ss 172–204)�� 1.55 s 561�� 28.3 s 561A�� 20.64 s 562�� 1.55 Capital Gains Tax Act 1979�� 8.14 Companies Act 1862�� 1.2, 15.4 Companies Act 1907 s 39�� 5.2 Companies Act 1948�� 15.4 s 208�� 4.8 Companies Act 1958 s 427(3)(d)�� 4.8 Companies Act 1962 Sch 9 para 11�� 5.3 para 12�� 15.4 para 13�� 15.4 para 13(1)�� 15.4, 16.28 para 13(2), (3)�� 15.4 Companies Act 1965�� 15.4 Sch 7�� 7.6 para 7(1)�� 15.4 para 7(2)�� 15.4, 15.6 para 7(3)�� 15.4 Companies Act 1985�� 24.17 s 425�� 5.2 Companies Act 2006�� 17.5, 18.16, 19.7, 19.8, 19.10, 19.16, 19.21, 19.23, 22.1, 25.1, 25.4, 25.6 s 618�� 17.2 Pt 17 Ch 10 (ss 641–653)�� 17.2 s 641�� 16.17, 17.2, 18.16, 23.1 s 645�� 25.10 s 658�� 26.31, 26.40 s 685�� 6.17 Pt 18 Ch 4 (ss 690–708)�� 6.31 s 707�� 6.31 s 738�� 7.2

Companies Act 2006 – contd s 829�� 19.21 s 829(1)�� 19.23 s 829(2)(d)�� 23.1 s 830�� 24.17 s 830(2)�� 23.1, 24.3 s 846�� 24.4, 24.5 Pt 26 (ss 895– 901)�� 2.12, 16.28, 17.1, 17.2, 17.3, 17.4, 19.14, 19.18, 19.20, 23.6, 23.10, 23.11, 24.2, 24.98, 26.8, 25.14, 26.58 s 895�� 16.21, 17.2, 17.4, 17.5, 17.6 s 895(2)�� 17.2 s 895(2)(a)�� 17.5 s 899�� 5.2, 16.21, 17.2, 17.6, 22.2, 26.58 s 899(1)�� 17.2 s 899(3)�� 17.2 s 900�� 17.5, 17.6, 18.16, 19.1, 19.2, 19.5, 19.6, 19.8, 19.9, 19.11, 19.12, 19.23, 24.38, 24.101, 26.58 s 900(1)(a)�� 4.13, 17.5, 22.2 s 900(1)(b)�� 17.5 s 900(2)(d)�� 4.8, 22.2, 26.58 s 900(3)�� 19.6 Pt 27 (ss 902–941)�� 2.12, 4.9, 4.14, 19.1, 19.2, 19.5, 19.10, 19.11 Pt 28 (ss 942–992)�� 25.8 s 974, 979�� 23.18 Companies (Consolidation) Act 1908 s 45, 120�� 5.2 Co-operative and Community Benefit Societies Act 2014�� 20.18 Corporation Tax Act 2009�� 26.52, 28.25 s 14�� 4.36 s 16�� 4.33, 4.36 s 17, 18�� 4.36 Pt 2 Ch 3A (ss 18A–18S)�� 27.2 Pt 3 (ss 34–201)�� 1.42, 1.53

xvii

Table of statutes Corporation Tax Act 2009 – contd s 139�� 18.38, 18.40 s 139(4)�� 18.40 s 159, 161�� 1.33 s 171�� 18.38 Pt 5 (ss 292–476)�� 1.8, 1.35, 1.37, 1.41, 1.42, 1.53, 7.6, 9.14, 9.21, 9.36, 20.33 s 295�� 1.39 s 297�� 1.42 s 299�� 1.42 s 302�� 1.38 s 303(1), (3)�� 1.38 s 304�� 1.39 s 306A(1)(a)–(c)�� 1.39 s 307�� 1.40 s 308�� 1.40, 1.41 s 308(1A)�� 1.40 s 313�� 1.43 s 320�� 1.39 s 320A�� 1.40 Pt 5 Ch 4 (ss 335–347)�� 1.44 s 335(6)�� 1.44 s 336�� 1.46 s 336(1)�� 1.45 s 336(2)�� 1.45, 1.46 s 336(3)�� 1.45 s 340, 341�� 1.46 s 344(1)�� 1.46 s 345�� 1.35, 1.46 s 346�� 1.46 Pt 5 Ch 5 (ss 348–352B)�� 1.54 s 348, 349�� 1.43 Pt 5 Ch 6 (ss 353–363A)�� 1.8 s 354(1)�� 1.43 s 358(1), (2)�� 1.43 s 361, 362�� 1.43 Pt 5 Ch 13 (ss 421–430)�� 26.54, 28.27 s 421(3)�� 28.27 s 422, 423, 426–428�� 26.54, 28.27 s 431–439�� 20.35 s 455B�� 1.40, 20.35, 26.54, 28.27 s 455C�� 1.58 s 464�� 1.39, 9.34 s 465B�� 1.46 s 465B(9)�� 1.46 s 466�� 1.43 Pt 6 (ss 477–569)�� 1.37 Pt 7 (ss 570–710)�� 1.48, 1.52, 1.54, 9.22, 20.33

Corporation Tax Act 2009 – contd s 571�� 1.50 s 573�� 1.53 s 574�� 1.53 s 576, 577, 579–581�� 1.49 s 582�� 1.49 s 582(2)�� 1.49 s 589�� 1.49 s 594A(1)(a), (b)�� 1.50 s 595�� 1.51, 1.52 s 596�� 1.50 s 597�� 1.52 s 597(1A)�� 1.51 s 598–603�� 1.52 s 604�� 1.50, 1.52 s 604A�� 1.51 s 605–624�� 1.52 s 625�� 1.52 s 625(3)�� 1.54 s 626, 627�� 1.52 s 628�� 1.52 s 628(2)�� 1.54 s 629, 630�� 1.52 s 631, 632�� 1.52, 1.54 s 633–673�� 1.52 Pt 7 Ch 9 (ss 674–688)�� 26.55, 28.28 s 674�� 1.52 s 674(2)�� 28.28 s 674(3)�� 26.55 s 675–679�� 1.52, 26.55, 28.28 s 680–681�� 1.52 s 682–688�� 1.52, 20.36 s 689–698�� 1.52 s 698A�� 20.36, 26.55, 28.28 s 698B�� 1.51 s 699�� 1.50, 1.52 s 700, 701�� 1.52 s 702�� 1.52, 1.54 s 702(8)�� 1.54 s 703–710�� 1.52 Pt 8 (ss 711–906)�� 1.13, 1.27, 1.28, 1.29, 1.30, 1.31, 1.32, 1.33, 1.34, 1.35, 1.67, 14.18, 18.1, 18.32, 18.36, 18.38, 18.40, 18.43, 20.33, 27.5, 27.28 s 712(1), (3)�� 1.30 s 713(1)�� 1.30 s 729(4)�� 18.43 s 734�� 1.31

xviii

Table of statutes Corporation Tax Act 2009 – contd s 735–737�� 1.31 s 738�� 1.31, 1.32 s 741�� 1.30 s 741(1)�� 18.36 s 775�� 1.9, 1.34, 1.35, 18.37 s 775(3)�� 1.34 s 776�� 1.34, 18.36, 20.34, 26.53, 28.26 s 776(2)�� 18.36 s 780�� 1.13, 1.35, 18.24, 24.108 s 782A�� 1.13, 1.35, 18.24 s 787�� 24.108 s 803�� 1.67 Pt 8 Ch 11 (ss 817–833)�� 26.53, 28.26 s 818�� 18.33, 20.34, 26.53, 28.26 s 818(1)�� 18.33, 18.36 s 818(2)�� 18.35, 18.36 s 818(3)�� 18.37 s 818(4)�� 18.39 s 818(5)�� 18.41 s 818(6)�� 18.33 s 819�� 26.53, 28.26 s 819(2)�� 28.26 s 819(3)�� 26.53 s 819(4), (5)�� 26.53, 28.26 s 820�� 26.53, 28.26 s 821�� 20.34 s 822�� 20.34 s 822(2)(b)�� 20.34 s 823�� 20.34 s 827�� 27.29 s 827(7)�� 27.29 s 828�� 27.29 s 828(1)�� 27.29 s 829�� 27.29 s 831�� 13.5, 18.41, 18.42, 20.34, 26.53, 27.29, 28.26 s 831(2)(a)�� 18.42 s 831(3)(a)�� 18.42 s 832�� 18.42, 20.34, 26.53, 28.26 s 833�� 18.42, 26.53, 28.26 s 835, 836�� 1.33 Pt 8 Ch 13 (ss 844–851)�� 1.33 s 845�� 1.34 s 845(1)�� 1.33 s 845(2)(a)�� 1.33 s 846�� 1.33 s 846(1A), (1B)�� 1.33

Corporation Tax Act 2009 – contd s 848(1)�� 1.34 s 859�� 1.35 s 864�� 1.67 s 880�� 1.29 s 882�� 1.29, 18.32 s 883, 884, 893�� 1.29 s 906�� 1.28 s 906(1)�� 18.32 Pt 9A (ss 931A–931W)�� 6.29, 8.5, 19.22, 19.26, 20.28, 24.18, 24.48 s 931RA�� 6.29, 19.22, 19.26, 22.11 Corporation Tax Act 2010 Pt 5 Ch 2 (ss 98–110)�� 20.61 Pt 5 Ch 6 (ss 157–182)�� 1.13, 2.9, 9.2, 9.3 s 162�� 9.4 s 162(2), (3)�� 9.4 s 439�� 24.58 s 450, 451�� 8.9, 24.58 Pt 15 (ss 731–751)�� 1.24, 1.57 s 731�� 1.3, 1.57, 13.5, 14.1 s 815�� 1.57 Pt 22 Ch 1 (ss 938–953)�� 19.29 s 949�� 18.39 s 1000�� 22.11 s 1000(1)B�� 6.29, 22.11, 25.2, 25.7 s 1000(1)B(a)�� 6.17, 25.7, 25.20 s 1022�� 6.17 s 1026�� 6.17 s 1030�� 19.21, 22.11, 23.1, 23.13 s 1031�� 19.23, 20.61, 20.62, 20.63 s 1033�� 6.17 Pt 23 Ch 5 (ss 1073–1099)�� 18.16, 18.18, 21.2, 22.10, 24.1, 24.7, 24.9, 24.11, 25.7 s 1073�� 24.8, 24.9 s 1074�� 24.10, 24.11, 24.85 s 1075�� 23.1, 24.6, 24.7, 24.11, 24.12, 24.87, 24.114 s 1075(1)�� 24.95 s 1076�� 22.5, 23.1, 24.1, 24.7, 24.12, 25.13, 24.14, 24.18, 24.20, 24.21, 24.23, 24.24, 24.28, 24.33, 24.43, 24.86, 24.87, 24.93, 26.3, 26.11 s 1076(a)�� 24.27, 24.37

xix

Table of statutes Corporation Tax Act 2010 – contd s 1077�� 23.1, 24.1, 24.7, 24.12, 24.13, 24.16, 24.18, 24.21, 25.23, 24.24, 24.28, 24.33, 24.39, 24.111, 26.3, 26.11, 26.19 s 1077(1)�� 19.21, 24.20 s 1077(1)(a)�� 24.20 s 1077(1)(a)(i)�� 24.17, 24.42, 24.44, 24.97, 24.99, 24.100, 24.109, 25.3, 26.15, 26.26 s 1077(1)(a)(ii)�� 24.17, 24.18, 24.23, 24.43, 24.44, 24.106, 25.3 s 1078�� 23.1, 24.1, 24.7, 24.12, 24.13, 24.19, 24.21, 24.24, 24.27, 24.91, 24.111, 26.3, 26.18, 26.21, 26.27, 26.28, 26.29, 26.32, 26.34, 26.41 s 1078(1)�� 24.20 s 1078(1)(b)�� 26.29 s 1079�� 24.7, 24.20, 24.100 s 1080�� 24.7, 24.22, 24.26, 24.62, 24.67 s 1081�� 24.7, 24.17, 24.24, 24.35, 24.65, 26.13, 26.17, 26.21, 26.29 s 1081(1)�� 24.25, 24.26, 24.33, 24.48, 26.3 s 1081(2)�� 24.27, 24.28, 24.33, 24.38, 24.94, 24.96 s 1081(2)(b)�� 24.38 s 1081(3)�� 24.29, 24.30 s 1081(4)�� 24.31, 24.32, 24.33 s 1081(4)(d)�� 24.32 s 1081(5)�� 1.24, 24.31, 24.32 s 1081(5)(a)�� 24.18, 24.26, 24.33, 24.34, 24.35, 24.63 s 1081(5)(b), (c)�� 24.34 s 1081(5)(d)�� 23.1, 24.11, 24.30, 24.35, 24.91 s 1081(5)(e)�� 24.30, 24.36 s 1081(5)(f)�� 24.36 s 1081(6)�� 24.31, 24.34 s 1081(7)�� 24.31, 24.33, 24.35 s 1082�� 24.7, 24.24, 24.37, 24.38, 24.65, 26.13, 26.17, 26.21, 26.29 s 1082(1)�� 24.43, 24.45, 24.48 s 1082(2)�� 24.46

Corporation Tax Act 2010 – contd s 1082(3)�� 24.38, 24.46, 24.48 s 1082(4)�� 24.38, 24.46 s 1083�� 24.7, 24.17, 24.24, 24.39, 24.65, 26.29 s 1083(1)�� 24.42 s 1083(2)�� 24.43 s 1083(3)�� 24.44 s 1083(4)�� 24.45 s 1083(5)�� 24.46 s 1084�� 24.7, 24.24, 24.40, 24.46, 24.65, 26.29 s 1084(1)�� 24.48 s 1085�� 24.7, 24.17, 24.18, 24.24, 24.28, 24.35, 24.38, 24.47, 24.48, 24.65, 26.29 s 1085(3)�� 24.48 s 1086�� 24.7, 24.34, 24.50, 24.51 s 1087�� 24.7, 24.50, 24.53 s 1088�� 24.7, 24.34, 24.50, 24.54 s 1088(2)�� 24.56 s 1089�� 24.7, 24.50, 24.57, 24.58 s 1090�� 24.7, 24.50, 24.56, 24.58, 24.61, 24.67 s 1090(3)�� 24.62 s 1091�� 14.8, 23.1, 24.1, 24.7, 24.64, 24.65, 24.73 s 1092�� 14.8, 24.56, 24.63, 24.64, 24.66, 24.67, 24.71, 24.73 s 1092(1), (2)�� 24.67 s 1092(4)�� 24.63, 24.67 s 1093�� 24.68, 24.72 s 1094�� 24.70, 24.72 s 1094(6), (7)�� 24.71, 24.73 s 1095�� 24.7, 24.74, 24.75, 24.76 s 1096�� 24.7, 24.74, 24.77 s 1096(1)–(3), (5)–(7)�� 24.78 s 1097�� 24.7, 24.79 s 1098�� 24.7, 24.58, 24.59, 24.60 s 1099�� 24.11, 24.15, 24.18, 24.28, 24.58, 24.82, 24.91 s 1099(1)�� 24.28, 24.56 s 1099(3)�� 24.11 xx

Table of statutes Corporation Tax Act 2010 – contd s 1115�� 25.7 s 1119�� 8.16, 16.26 s 1154(3)�� 1.8 s 1176(1)�� 24.62 s 1119�� 16.6, 24.33 s 1122�� 24.62 s 1124�� 16.17

Finance Act 1968 Sch 12 para 15(2)�� 18.21 para 16�� 27.3 Finance Act 1969�� 27.3 Sch 19 para 18�� 27.3 Finance Act 1977�� 27.4 s 41�� 18.29 Finance Act 1980�� 22.10 Finance Act 1986 s 66�� 2.4, 6.31 s 75�� 2.10, 2.11, 8.22, 14.20, 15.5, 28.31 s 76�� 2.10 s 77�� 2.10, 2.12, 2.14, 8.22, 14.20, 23.22, 25.26, 28.31 s 77A�� 2.12, 2.14, 8.22, 14.20, 23.22, 25.26 s 79�� 9.37 s 87�� 2.5 s 89A�� 6.31 Sch 18 para 87B�� 4.36 Finance Act 1988�� 8.13 Finance Act 1996�� 1.48, 9.14, 9.21, 9.24 Finance Act 1997�� 9.9, 10.1 Finance Act 1998�� 1.7, 9.32, 24.24 Sch 18�� 4.37 para 87A, 87B�� 4.37 Finance Act 1999�� 15.7 Sch 13�� 8.22 para 2�� 2.7, 10.21 Finance Act 2000�� 4.4, 18.21, 25.27 Sch 15 para 82, 83, 85–87�� 12.19 Finance Act 2002�� 1.11, 1.11, 1.13, 1.27, 1.28, 15.7, 16.1, 18.19, 22.10, 24.94 Finance Act 2003�� 27.7 Pt 4 (ss 42–124)�� 2.15 s 53�� 2.17, 25.27 s 54�� 2.17 s 54(3)�� 25.27 s 54(4)�� 2.17 s 75A�� 2.19, 2.25, 2.30 Sch 4�� 2.16 Sch 4A�� 2.16 Sch 4ZA�� 2.16

E European Communities Act 1972�� 4.1, 4.3 European Union (Withdrawal) Act 2018�� 4.1, 4.3 European Union (Withdrawal Agreement) Act 2020�� 4.1, 4.3 F Finance Act 1914�� 7.2 Finance Act 1930 s 42�� 2.9, 8.22 s 55�� 15.5 Finance Act 1960�� 1.3, 1.58 s 28�� 1.24, 1.57, 13.5 Finance Act 1962�� 1.3, 1.4, 5.3, 5.6 Sch 7 para 11(1)�� 7.1 Sch 9 para 10�� 5.3 para 12(2)�� 8.7 para 13(1)�� 18.2, 18.18 Finance Act 1965�� 1.2, 1.3, 1.4, 1.68 s 22(4)�� 5.4 Sch 7�� 5.3, 5.4, 5.6 para 4�� 5.4 para 4(1)(a)�� 5.4 para 6(1)�� 8.13 para 6(2)�� 8.7 para 7(1)�� 15.6, 16.28, 18.2 para 7(2)�� 16.28, 18.18 para 8�� 27.3 para 10(1)(a)�� 5.3 para 10(2), (3)�� 5.3 Sch 13 para 2(1)�� 8.13 Finance Act 1967 s 27�� 2.9 xxi

Table of statutes Finance Act 2003 – contd Sch 7�� 2.18, 2.21 Pt 1�� 25.27 para 1, 2�� 25.27 para 3, 4ZA�� 25.28 Sch 15�� 2.17 Pt 3 (paras 9–40)�� 2.17 Finance Act 2004�� 1.59, 12.14 Pt 7 (ss 306–319)�� 2.22 s 306�� 1.59 Finance Act 2005�� 4.30 Finance Act 2006�� 1.7, 1.58 Finance Act 2007�� 20.1, 20.3, 20.11 s 110�� 4.24, 4.30, 9.21, 20.3, 20.4 s 110(1)�� 20.4 s 110(1)(a), (b)�� 20.5 s 110(2)�� 20.6 s 110(3)�� 20.8 s 110(4)�� 20.10 s 110(5)�� 20.10 s 110(5)(c)�� 20.11 s 110(6)�� 20.10 Finance Act 2008�� 7.2 Sch 36�� 24.81 Finance Act 2010�� 27.13 Finance Act 2011�� 1.10, 1.13, 1.17, 1.24, 8.20, 18.23, 25.23, 28.11 Finance Act 2013�� 1.56 s 206–215�� 1.61, 2.19 Sch 43�� 1.61 Finance Act 2014�� 1.64 Finance Act 2016 s 87�� 12.20 s 137�� 2.12, 2.14 Sch 14�� 12.20 Finance Act 2018�� 1.35 Finance Act 2019�� 1.7, 1.13, 9.4, 18.23 Finance Act 2020�� 1.7, 1.9, 1.29, 18.32 Sch 7�� 1.9 Finance (No 2) Act 2005�� 4.34 Finance (No 2) Act 2015�� 1.33, 1.40, 1.43, 1.51 Finance (No 2) Act 2017�� 1.11, 1.12, 1.13, 1.18, 1.23 Finance (No 3) Act 2010�� 6.29 Finance (No 2) Bill 1980�� 24.1 Fixed-term Parliaments Act 2011�� 28.1

I Income and Corporation Taxes Act 1970�� 8.14 s 268�� 27.3, 27.4, 27.27 s 268(1), (2)�� 27.26 s 268A�� 27.3, 27.4, 27.6, 27.7, 27.27 s 268A(1), (3)–(5), (8)�� 27.26 s 269�� 27.4 Income and Corporation Taxes Act 1988 s 208�� 6.29 s 209(2)(b)�� 6.28 s 461A�� 18.39 s 706�� 13.11 s 815A�� 20.43, 28.17 s 832(1)�� 18.4 Sch 18�� 2.9 Income Tax Act 1842�� 7.2 Income Tax Act 2007 s 185�� 12.3 s 204�� 12.6, 12.9 s 209�� 12.3 s 247�� 12.3 s 247(3)�� 12.3, 12.4, 12.6, 12.16 s 247(4)�� 12.3 s 257DG�� 12.11 s 257FA�� 12.11, 12.13 s 257HB�� 12.11, 12.13 s 257HB(3)�� 12.11, 12.12 s 257HB(4)�� 12.11 s 266, 270�� 12.16 s 326, 327�� 12.15 s 330�� 12.15 s 682–713�� 1.3, 1.24, 1.57, 13.5, 14.1 s 714, 752�� 1.54 Income Tax (Earnings and Pensions) Act 2003�� 10.19, 10.20 Pt 7 (ss 417–554)�� 6.9, 10.19 Pt 7A (ss 554A–554Z21)�� 1.59 s 421B(1)–(3)�� 10.19 s 421D(1), (3)�� 6.9 Income Tax (Trading and Other Income) Act 2005 s 382�� 24.95 s 383�� 6.29, 22.15, 22.10, 24.6 Industrial and Provident Societies Act 1965�� 4.29, 16.2, 20.18

xxii

Table of statutes Insolvency Act 1986 s 110�� 4.13, 23.2, 23.3, 23.4, 23.8, 23.12, 23.19, 23.26 s 110(1)�� 23.2, 23.7, 23.12 s 110(2)�� 23.2, 23.7, 23.8 s 110(3)�� 23.2 s 110(3)(a)�� 23.2 s 111�� 23.19 Interpretation Act 1978 Sch 1�� 24.13 J Joint Stock Companies Act 1844�� 1.2 Joint Stock Companies Act 1856�� 1.2 L Land and Buildings Transaction Tax (Scotland) Act 2013�� 2.23 s 47�� 2.25 Land Transaction Tax and Anti-avoidance of Devolved Taxes (Wales) Act 2017�� 2.26 Limited Liability Act 1855�� 1.2 S Scotland Act 2012 s 29�� 2.23 Small Business, Enterprise and Employment Act 2015 s 84�� 6.31 Stamp Act 1891�� 6.6 s 14, 17�� 2.4 s 122(1)�� 9.37 T Taxation of Chargeable Gains Act 1992�� 1.34, 8.13, 24.13 Pt I (ss 1–14H)�� 1.7 s 1E(7)�� 1.7 s 2A�� 1.7 s 2B(3)�� 20.26, 26.9, 26.17, 26.24, 26.34, 28.8, 28.11 s 2C�� 26.9, 26.24, 28.5 s 2C(1)�� 26.34 s 2E�� 6.17 s 8(4)�� 6.17

Taxation of Chargeable Gains Act 1992 – contd s 16A�� 1.13 s 17�� 1.9, 1.46, 6.17, 6.21, 8.13, 8.19, 11.2, 11.8, 15.4, 24.15, 26.36, 28.10 s 17(1)�� 5.4, 11.3, 18.15, 22.10 s 17(1)(a)�� 18.15, 22.10 s 18�� 6.21, 8.13, 8.19, 11.8, 15.4, 26.36, 28.10 s 21, 22�� 10.1 s 23�� 7.10 s 24�� 1.13, 20.28, 20.58, 20.59, 20.60, 22.11, 26.41 s 24(2)�� 5.4 s 25�� 28.11 s 25(3)�� 26.36, 28.10 s 29�� 5.5 s 37�� 1.46, 6.17, 19.23, 19.24 s 39�� 6.17, 19.23 s 42�� 6.21, 6.23, 6.29, 10.18 s 48�� 10.3, 10.11 s 52(4)�� 10.18 s 53(1B)�� 6.27 s 54(4)�� 6.27 s 58(1)�� 7.14, 9.28, 13.22 s 62(4)�� 7.14, 9.28 s 99(1)(b)�� 8.16 s 104�� 6.28 s 115�� 7.14, 9.1, 9.6, 9.9, 9.24, 9.26, 27.13, 28.11 s 116�� 7.6, 7.10, 9.6, 9.8, 9.9, 9.10, 9.12, 9.14, 9.34, 9.36, 10.3, 10.9, 10.18, 11.6, 11.7, 18.4 s 116(1)�� 9.7, 9.10, 9.35 s 116(1)(a)�� 9.8 s 116(1)(b)�� 9.10 s 116(2)�� 9.7, 9.8 s 116(3)�� 9.11, 9.16 s 116(4)�� 9.11, 9.16, 9.35 s 116(4A)�� 9.13 s 116(5)�� 9.15, 9.16, 9.35 s 116(6)�� 9.15, 9.16, 9.22, 9.35 s 116(7)�� 9.17, 9.20, 9.30, 9.35 s 116(8)�� 9.19 s 116(8A)�� 9.21, 9.22, 9.24 s 116(8AA), (8B)�� 9.21, 9.22

xxiii

Table of statutes Taxation of Chargeable Gains Act 1992 – contd s 116(9)�� 9.23, 9.35 s 116(10)�� 9.25, 9.26, 9.32, 11.10 s 116(10)(a)�� 9.9, 9.28, 9.30, 9.32, 9.35, 10.18, 11.6, 27.13 s 116(10)(b)�� 9.9, 9.26, 9.30, 9.35, 10.18, 11.6 s 116(11)�� 9.27, 9.32 s 116(12)�� 9.18, 9.29, 9.30, 9.35 s 116(13)�� 9.18, 9.29 s 116(14)�� 9.18, 9.29, 9.30, 9.35 s 116(15)�� 9.31, 9.32 s 116(16)�� 9.33, 9.34 s 117�� 9.2 s 117(A1)�� 9.2 s 117(1)(b)�� 9.5, 9.9 s 117(2)�� 9.2 s 117(2)(b)�� 9.5 s 117(3)–(6C)�� 9.2 s 122 �� 6.10, 6.17, 6.21, 6.29, 7.10, 19.22, 19.23, 20.28, 20.58, 20.59, 20.60, 22.11, 24.13, 24.87, 24.95, 25.20, 26.41 s 122(1)�� 22.11 s 122(5)�� 22.11, 23.13, 24.13 s 122(5)(b)�� 19.23, 22.10, 24.87 s 122(6)�� 6.29, 19.22, 20.28 s 123�� 6.10, 6.21 s 126�� 5.2, 5.3, 5.4, 5.6, 6.2, 6.6, 6.7, 6.17, 7.6, 7.8, 8.1, 8.3, 16.8, 16.23, 16.26, 18.6 s 126(1)�� 5.3, 6.3, 6.4, 6.6, 6.7, 6.8, 6.9, 6.15, 6.17, 6.17, 6.28 s 126(1)(a)�� 6.7 s 126(1)(b)�� 6.7, 18.6 s 126(2)�� 6.5, 6.6, 6.15 s 126(2)(a)�� 6.8, 6.9, 6.10, 6.12, 6.28 s 126(2)(b)�� 6.7, 6.15 s 126(3)�� 6.4, 6.15, 6.16, 6.17, 6.28

Taxation of Chargeable Gains Act 1992 – contd s 127�� 1.13, 5.2, 5.3, 5.4, 6.2, 6.3, 6.7, 6.9, 6.10, 6.18, 6.27, 6.28, 7.4, 7.6, 7.10, 8.3, 8.12, 8.13, 8.19, 9.8, 9.12, 9.36, 10.1, 10.9, 11.2, 11.3, 11.4, 11.8, 12.9, 12.16, 12.19, 18.5, 18.6, 19.26, 23.8, 23.14, 24.95, 24.100, 24.104, 24.105, 25.21, 25.22, 27.13, 27.18 s 128�� 5.2, 6.2, 6.3, 6.4, 6.7, 6.10, 6.15, 6.20, 6.28, 6.29, 7.4, 7.10, 8.3, 8.12, 9.8, 9.12, 10.9, 18.5 s 128(1)�� 6.21, 6.23, 6.28 s 128(2)�� 5.4, 6.15, 6.21 s 128(2)(a)�� 6.21 s 128(2)(b)�� 6.21, 6.28 s 128(3)�� 6.4, 6.21, 6.23, 7.10 s 128(3)(a), (b)�� 6.21 s 128(4)�� 6.21, 7.10 s 129�� 5.2, 6.2, 6.3, 6.7, 6.21, 6.22, 6.23, 6.25, 6.28, 7.4, 7.10, 8.3, 8.12, 9.8, 9.12, 10.9, 10.18, 18.5, 22.10, 23.13, 24.95 s 130�� 5.2, 6.2, 6.3, 6.7, 6.23, 6.24, 6.25, 6.28, 7.4, 8.3, 8.12, 9.8, 9.12, 10.9, 10.18, 18.5, 22.10, 23.13, 24.95 s 130(1)�� 6.25 s 130(1)(a)�� 6.25 s 130(2)�� 6.25, 6.28 s 131�� 5.2, 6.2, 6.3, 6.7, 6.21, 6.26, 7.4, 8.3, 8.12, 9.8, 10.9, 18.5 s 132�� 6.4, 7.2, 7.6, 7.8, 9.9, 9.10, 10.9, 10.18 s 132(1)�� 7.3, 7.4, 7.6, 7.10, 9.8, 9.10 s 132(2)�� 7.3 s 132(2)(a)(i)�� 7.6 s 132(3)�� 7.5, 7.6, 10.18 s 132(3)(a)�� 7.2 s 132(3)(a)(i)�� 7.10 s 132(3)(a)(ia)�� 7.6, 7.8 s 132(3)(a)(ib)�� 7.6 s 132(3)(a)(iii)�� 7.6

xxiv

Table of statutes Taxation of Chargeable Gains Act 1992 – contd s 132(3) – contd s 132(3)(b)�� 7.2, 9.2 s 132(4)�� 7.7 s 132(5)�� 7.2, 7.7, 7.8 s 133�� 7.2, 7.4, 7.9, 7.10, 7.12 s 133(1)�� 7.10 s 133(2)�� 7.10 s 133(2)(a), (b)�� 7.10 s 133(4)�� 7.10, 9.30 s 133(4)(b)�� 7.10 s 133A�� 7.11 s 134�� 7.4, 7.6, 7.13, 7.14, 9.6, 9.26 s 134(1)�� 7.14 s 134(4)�� 7.14, 9.28 s 134(5), (6)�� 7.14 s 135�� 1.13, 4.22, 6.6, 7.6, 8.3, 8.5, 8.7, 8.13, 8.14, 8.16, 8.19, 8.20, 9.8, 9.10, 9.35, 9.36, 10.1, 10.3, 10.9, 10.18, 11.1, 11.2, 11.3, 12.1, 12.3, 12.4, 12.5, 12.10, 12.12, 12.13, 12.14, 12.19, 12.20, 13.1, 13.2, 13.5, 13.8, 13.12, 13.22, 14.5, 15.4, 16.23, 18.27, 20.30, 20.47, 23.18, 25.8, 27.7, 27.18 s 135(1)�� 8.4, 8.5 s 135(2)�� 8.5, 8.6, 8.25 s 135(3)�� 8.11, 8.19 s 135(4)�� 8.8, 8.15 s 135(4)(a)�� 8.19 s 135(5)�� 8.8, 8.15, 13.8, 13.22, 18.12 s 135(6)�� 8.18 s 136�� 7.8, 10.1, 11.1, 12.20, 14.4, 13.5, 13.8, 13.22, 15.2, 15.4, 16.3, 16.6, 16.8, 16.23, 16.28, 18.1, 18.2, 18.3, 18.4, 18.6, 18.8, 18.10, 18.18, 18.21, 18.27, 18.34, 18.44, 18.45, 19.22, 19.24, 19.25, 19.26, 20.30, 20.47, 20.51, 20.53, 20.55, 20.55, 21.1, 22.15, 23.1, 23.6, 23.13, 23.14, 23.18, 24.38, 24.104, 24.105, 25.3, 25.8, 25.20, 25.21, 25.22, 26.9, 26.13, 26.17, 26.21, 26.24, 26.50, 27.18 s 136(1)�� 18.2, 18.3 s 136(1)(a)�� 19.25, 23.13, 24.104, 25.20

Taxation of Chargeable Gains Act 1992 – contd s 136(1) – contd s 136(1)(b)�� 19.25, 23.13, 24.104, 25.20 s 136(2)�� 18.2 s 136(2)(b)�� 18.6 s 136(3)�� 18.7 s 136(4)�� 18.9 s 136(4)(a)�� 18.4 s 136(4)(b)(ii)�� 18.10 s 136(5)�� 13.8, 13.22, 18.10 s 136(6)�� 18.13, 20.55, 26.51 s 137�� 1.24, 8.5, 8.7, 12.3, 12.11, 14.1, 18.6, 18.14, 20.30, 20.55, 26.51 s 137(1)�� 10.5, 10.9, 10.11, 13.5, 13.7, 13.12, 13.15, 13.20, 13.22, 14.1, 14.4, 14.6, 14.10, 18.27, 24.24, 24.33, 24.35 s 137(2), (3)�� 13.19, 13.20 s 137(4), (5)�� 13.21 s 137(6)�� 13.8, 13.20 s 138�� 9.9, 10.5, 14.6, 14.12, 14.14, 14.16, 15.6, 16.6, 18.14, 18.42, 20.30, 20.45, 24.65, 26.38, 28.13 s 138(1)�� 12.15, 14.2, 14.3, 14.4 s 138(2)�� 14.7, 18.27 s 138(3)�� 14.9, 14.12, 18.27 s 138(4)�� 14.10, 14.11, 18.27 s 138(5)�� 14.13, 14.14, 18.27 s 138A�� 10.1, 10.3, 10.5, 10.6, 10.9, 10.12, 10.15, 10.17, 10.18, 10.20 s 138A(1)�� 10.2, 10.9, 10.17 s 138A(2)�� 10.4, 10.7, 10.9 s 138A(2A)�� 10.6, 10.7, 10.9, 10.15 s 138A(3)�� 10.5, 10.8, 10.9, 10.11, 10.15, 10.18 s 138A(3)(a)�� 10.3 s 138A(3)(a)(ia)�� 10.18 s 138A(3)(b), (d)�� 10.18 s 138A(4)�� 10.10, 10.11, 10.13, 10.15 s 138A(4)(a)�� 10.15 s 138A(4)(b), (d)�� 10.17 s 138A(4A)�� 10.11, 10.12, 10.13, 10.15 s 138A(5), (6)�� 10.14

xxv

Table of statutes Taxation of Chargeable Gains Act 1992 – contd s 138A – contd s 138A(7)–(10)�� 10.3, 10.16, 10.17 s 138A(11)�� 10.17 s 139 �� 1.24, 2.11, 13.5, 15.2, 15.4, 16.28, 18.15, 18.16, 18.17, 18.18, 18.19, 18.21, 18.27, 18.29, 18.32, 18.43, 18.44, 18.45, 19.20, 19.26, 20.22, 20.24, 20.30, 20.34, 20.35, 20.36, 20.60, 20.63, 20.64, 21.1, 22.15, 23.1, 23.6, 23.12, 23.15, 24.15, 24.65, 24.103, 24.107, 24.108, 25.3, 25.19, 25.22, 26.9, 26.13, 26.17, 26.21, 26.24, 26.26, 26.36, 26.53, 28.10, 28.26 s 139(1)�� 14.4, 18.17, 18.18, 18.23, 18.34, 26.29 s 139(1)(a)�� 19.20, 23.12, 24.103, 25.19 s 139(1)(b)�� 19.20, 23.12, 25.19 s 139(1)(c)�� 18.23, 19.20, 23.12, 24.103, 25.19 s 139(1A)�� 18.20, 18.36, 19.20, 23.12, 24.103, 25.19, 26.9, 26.24 s 139(1A)(a)�� 26.9, 26.17, 26.24, 26.34 s 139(1B)�� 18.18, 18.22, 18.23 s 139(2)�� 18.24, 18.25 s 139(3)�� 18.24 s 139(4)�� 18.24, 18.25 s 139(5)�� 13.5, 14.4, 18.23, 18.26, 18.27, 18.29, 18.42 s 139(6)�� 18.28, 18.29 s 139(7)�� 18.28 s 139(9)�� 18.30 s 140�� 20.41, 27.1, 27.2, 27.3, 27.4, 27.5, 27.7, 27.9, 27.11, 27.13, 27.18, 27.21, 27.22, 27.23, 27.28, 27.29, 27.30, 27.32, 28.2, 28.3, 28.15, 28.16, 28.18, 28.19, 28.20, 28.23, 28.30, 28.32 s 140(1)�� 27.6, 27.7 s 140(1)(b), (c)�� 27.7 s 140(1)(d)�� 27.7, 27.11

Taxation of Chargeable Gains Act 1992 – contd s 140 – contd s 140(2)�� 27.8, 27.25 s 140(3)�� 27.7, 27.10, 27.13, 27.18 s 140(4)�� 27.11, 27.12, 27.13, 27.18, 27.23, 27.25, 27.27, 27.29 s 140(4A)�� 27.12 s 140(4B)�� 27.12, 27.13 s 140(5)�� 27.11, 27.14, 27.15, 27.19, 27.25, 27.27, 27.29 s 140(6)�� 27.13, 27.16, 27.18 s 140(6)(a)�� 27.18 s 140(6)(b)�� 27.18, 27.19 s 140(6A)�� 27.20, 27.22, 27.29 s 140(6AA)�� 27.23, 27.23, 27.29 s 140(6AA)(b)�� 27.23 s 140(6AA)(b)(ii)�� 27.23 s 140(6B)�� 27.24, 27.25 s 140(6C)�� 27.24 s 140(7), (8)�� 27.26 s 140A�� 4.21, 4.24, 9.28, 20.1, 20.5, 20.24, 26.1, 26.29, 26.30, 26.32, 26.36, 26.38, 26.43, 26.49, 26.52, 26.53, 27.1, 27.2, 27.23, 28.1, 28.3, 28.4, 28.5, 28.8, 28.10, 28.11, 28.13, 28.15, 28.24, 28.25, 28.26, 28.30 s 140A(1)�� 26.30, 28.2, 28.4, 28.8, 28.11, 28.25, 28.26, 28.27, 28.28 s 140A(1)(a)�� 28.5 s 140A(1)(c)–(e)�� 26.32 s 140A(1A)�� 26.25, 26.27, 26.29, 26.31, 26.32, 26.34, 26.37, 26.38, 26.41, 26.50, 26.51, 26.53, 26.54, 26.55, 26.61, 26.62, 28.6, 28.8 s 140A(1A)(b)�� 26.29, 26.32 s 140A(1B), (1C)�� 26.27, 26.31, 26.32, 28.6 s 140A(1D)�� 26.27, 26.31, 28.6 s 140A(2)�� 26.29, 26.32, 26.33, 26.34, 28.5, 28.7, 28.8 s 140A(3)�� 26.32, 26.33, 26.34, 28.5, 28.7, 28.8 s 140A(4)�� 26.35, 28.9

xxvi

Table of statutes Taxation of Chargeable Gains Act 1992 – contd s 140B�� 4.21, 4.24, 20.1, 20.5, 26.1, 26.32, 26.37, 26.48, 27.1, 27.2, 27.29, 28.1, 28.3, 28.5, 28.12, 28.22, 28.30 s 140B(1A)�� 26.25 s 140C�� 4.21, 4.24, 20.1, 20.5, 20.24, 20.41, 20.43, 26.1, 26.29, 26.39, 26.41, 26.43, 26.49, 26.52, 26.56, 26.57, 27.1, 27.2, 27.13, 27.20, 27.21, 27.22, 27.23, 28.1, 28.3, 28.14, 28.15, 28.16, 28.18, 28.20, 28.21, 28.23, 28.24, 28.25, 28.29, 28.30 s 140C(1)�� 26.39, 26.41, 28.2, 28.14, 28.15, 28.25, 28.29 s 140C(1A)�� 26.28, 26.29, 26.40, 26.41, 26.51, 26.56, 26.64 s 140C(1A)(c)�� 26.50 s 140C(1B), (1C)�� 26.40, 26.41 s 140C(2)�� 26.42, 28.17 s 140C(3)�� 26.42, 26.43, 28.16, 28.17, 28.18 s 140C(4)�� 26.46, 28.19 s 140C(5)�� 20.43, 26.42, 28.17 s 140D�� 4.21, 4.24, 20.1, 20.5, 26.1, 26.41, 26.47, 27.1, 27.2, 27.29, 28.1, 28.3, 28.15, 28.21, 28.30 s 140DA�� 26.27, 26.49, 26.50, 26.51, 28.24 s 140DA(1), (2)�� 26.51 s 140E�� 4.29, 9.28, 20.1, 20.3, 20.5, 20.12, 20.13, 20.14, 20.16, 20.18, 20.22, 20.26, 20.32, 20.34, 20.39, 20.41, 20.45, 20.49, 20.53, 20.55, 20.57, 20.58, 20.60, 20.63, 20.64, 26.1, 27.25, 28.1 s 140E(1)�� 20.15, 20.34, 20.35, 20.36 s 140E(2)�� 20.21 s 140E(2)(a), (b)�� 20.22 s 140E(2)(c)�� 20.63 s 140E(2)(d)�� 20.19, 20.22 s 140E(2)(d)(ii)�� 20.28 s 140E(2)(e)�� 20.28

Taxation of Chargeable Gains Act 1992 – contd s 140E – contd s 140E(3)�� 20.23 s 140E(4)�� 20.22, 20.25 s 140E(5)�� 20.25, 20.26, 20.57 s 140E(6)�� 20.25, 20.26, 20.32 s 140E(7)�� 20.27, 20.58 s 140E(8)�� 20.24, 20.29, 20.57 s 140E(9)�� 20.31, 20.45, 20.57 s 140F�� 4.29, 20.1, 20.3, 20.5, 20.12, 20.13, 20.18, 20.37, 20.41, 20.45, 20.46, 20.49, 20.53, 20.58, 20.60, 20.63, 26.1, 28.1 s 140F(1)�� 20.38 s 140F(2)�� 20.40 s 140F(2)(a), (b), (e)�� 20.41 s 140F(3)�� 20.42 s 140F(4)�� 20.42, 20.44, 28.17 s 140F(5)�� 20.44 s 140G�� 4.29, 20.1, 20.3, 20.5, 20.12, 20.13, 20.47, 20.49, 20.51, 20.53, 20.57, 20.58, 26.1, 28.1 s 140G(1)�� 20.48 s 140G(2)�� 20.50, 20.51, 20.55 s 140G(3)�� 20.52, 20.53, 20.55 s 140G(4)�� 20.54 s 140G(5)�� 20.55, 20.56, 20.57 s 140GA�� 4.28, 20.1, 20.5, 20.12, 20.13, 20.28, 20.58, 20.59 s 140H–140L�� 20.1, 20.5, 26.1, 28.1 s 147�� 13.8, 13.22 s 150A�� 12.12 s 150A(8)�� 12.4, 12.5 s 150A(8A)�� 12.6 s 150A(8B)�� 12.6, 12.8 s 150A(8C), (8D)�� 12.6 s 154�� 20.64, 23.17 s 162�� 8.19, 27.3 s 169Q, 169R�� 8.5, 18.6 s 169VN–169VT�� 12.20 s 170�� 10.17, 16.17 s 170(1)�� 18.25 s 170(3)(a)�� 1.8 s 170(3)(b)�� 1.8 s 170(7)�� 1.8

xxvii

Table of statutes Taxation of Chargeable Gains Act 1992 – contd s 171�� 1.7, 1.8, 1.9, 1.26, 1.34, 1.36, 1.46, 1.47, 8.5, 8.13, 11.2, 11.4, 11.6, 11.7, 11.8, 19.20, 19.26, 20.22, 20.26, 24.48, 27.18, 27.19, 28.5, 28.8, 28.15 s 171(1)�� 7.14, 8.13, 8.14, 8.19, 9.28, 13.22, 19.27, 27.18 s 171(1)(a)�� 11.8 s 171(1A)�� 27.19 s 171(3)�� 8.13, 8.14, 8.21, 11.2, 11.3, 11.10, 27.18 s 171A�� 1.7 s 175�� 23.17 s 175(3)�� 23.17 s 176�� 23.17 s 179�� 1.10, 1.13, 1.46, 8.20, 18.23, 19.28, 20.64, 23.15, 24.6, 24.7, 24.15, 24.88, 24.89, 24.108, 24.109, 25.23, 27.15, 28.11, 28.16 s 179(3B)�� 1.10, 1.13 s 179(3D)�� 8.20, 18.23 s 179(3E)�� 8.20 s 179(4)�� 1.35 s 179ZA�� 1.10 s 185�� 4.33 s 192�� 22.10, 24.1, 24.33, 24.83 s 192(1)�� 24.84 s 192(2)�� 24.86, 24.87, 24.105 s 192(2)(a)�� 24.13, 24.87, 24.95 s 192(2)(b)�� 24.95, 24.96, 26.13 s 192(3)�� 24.88, 24.89, 24.108 s 192(4)�� 24.88, 24.89 s 192(5), (6)�� 24.90 s 243�� 7.10 s 251�� 7.2 s 251(6)�� 7.8 s 254(2)�� 9.32 s 272�� 6.23 s 272(1)�� 1.33 s 273, 274�� 6.23 s 284A, 284B�� 15.7 s 288�� 8.19 s 288(1)�� 8.9

Taxation of Chargeable Gains Act 1992 – contd Sch 5AA�� 2.11, 14.5, 15.2, 15.4, 15.7, 16.1, 16.3, 16.6, 16.8, 16.28, 18.1, 18.4, 18.9, 18.18, 18.21, 18.31, 18.34, 19.14, 19.15, 19.16, 19.17, 19.18, 19.19, 19.25, 20.22, 22.6, 22.8, 22.14, 23.6, 23.8, 23.10, 23.11, 23.12, 24.94, 24.98, 24.99, 24.100, 24.101, 24.102, 24.103, 24.104, 25.14, 25.20, 25.22, 26.15, 25.16, 25.17, 25.18, 26.9, 26.24 para 1�� 16.3 para 2�� 16.5, 16.27, 18.9, 18.10 para 3�� 16.7, 16.8, 16.23 para 4�� 16.9, 16.11, 19.17 para 4(1)�� 16.11, 16.13, 16.19, 23.9 para 4(1)(a)�� 16.10 para 4(1)(a)(i)�� 16.11 para 4(1)(a)(ii)�� 16.11, 16.15, 18.18 para 4(1)(b)�� 16.12 para 4(1)(b)(i)�� 16.13, 19.17 para 4(1)(b)(ii)�� 16.13, 16.15, 18.18 para 4(2)�� 16.13, 16.14, 16.15 para 4(3)�� 16.11, 16.13, 16.16, 16.17 para 4(4)�� 16.18, 16.19 para 5�� 16.20, 16.21, 17.1 para 5(b)�� 16.21 para 6�� 16.22, 16.23, 16.25, 16.27, 18.8, 23.8, 24.100, 25.22 para 7�� 16.24 para 8�� 16.26 para 8(1)�� 16.6 para 8(1)(a)�� 18.4 para 8(1)(b)�� 18.12 para 8(2)�� 16.23 Sch 5B para 3(1)�� 12.5 para 8(1)�� 12.9 Sch 5BB�� 12.13

xxviii

Table of statutes Taxation of Chargeable Gains Act 1992 – contd Sch 7A�� 1.7 Sch 7AA�� 1.7 Sch 7AC�� 1.11, 1.21, 1.67, 11.1, 11.2, 11.3, 22.7, 23.12, 24.15, 27.13 Pt II (paras 7–17)�� 1.13 para 1�� 11.4 para 2�� 1.20 para 3�� 1.20, 1.22 para 3(3)�� 1.25 para 3A�� 1.20, 1.23 para 4�� 11.2, 11.3, 11.6, 11.9, 19.26 para 4(1)�� 11.3, 11.10 para 4(1)(a)�� 11.6 para 4(1)(b)�� 11.2, 11.8, 23.14, 24.105, 25.21 para 4(1)(c)�� 24.96 para 4(3)�� 11.10, 19.26, 24.87 para 4(3)(a)�� 11.4, 11.7, 23.14, 24.96, 24.105, 25.21, 27.13 para 4(5)�� 11.2, 23.14 para 5�� 1.67, 27.13 para 6�� 8.19, 11.4, 11.8, 11.9, 19.20, 22.15, 25.19 para 6(1)(a)�� 11.2, 11.3, 11.10, 18.19, 23.12 para 8A�� 1.23 para 15A�� 1.13, 1.18 para 15A(2)(b)–(d)�� 1.17 para 19(2B)�� 1.17 para 30A�� 1.23 Sch 9 para 1�� 7.14 Sch 11�� 6.23 Taxation (International and Other Provisions) Act 2010 s 116�� 26.52, 26.56, 28.25, 28.29 s 116(2)�� 28.29

Taxation (International and Other Provisions) Act 2010 – contd s 116(3)�� 26.56 s 116(6), (7)�� 27.29 s 117�� 26.52, 26.56, 28.25, 28.29 s 117(3)–(6)�� 26.56, 28.29 s 118, 119�� 20.46 s 122�� 20.43, 26.42, 26.43, 26.44, 26.45, 28.5, 28.17, 28.18 s 122(5)(b)�� 26.45 Pt 4 (ss 146–217)�� 1.33 Pt 6A (ss 259A–259NF)�� 1.37 s 259M�� 1.58 Pt 10 (ss 372–382)�� 1.37 Tax Collection and Management (Wales) Act 2016 Pt 3A (ss 81A–81I)�� 2.30 V Value Added Tax Act 1994 s 7A�� 3.5, 8.24, 27.32 s 8�� 3.10 s 9�� 27.32 s 26(2)(b)�� 27.32 s 43–43D�� 3.11 s 44�� 8.30 s 49(1)�� 3.12 Sch 1 para 1(2)�� 3.12 Sch 4A para 1–9A�� 3.10, 8.24 para 16�� 3.5, 8.24 Sch 9 Group 5 Item 5�� 3.9 Item 6�� 3.5, 8.24, 9.38 Sch 10�� 3.12 W Wales Act 2014 s 16(5), (6)�� 2.26

xxix

xxx

Table of statutory instruments [All references are to paragraph numbers] A Annual Tax on Enveloped Dwellings Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2013, SI 2013/2571 reg 4�� 1.59 C Companies Act 2006 (Amendment of Part 17) Regulations 2015, SI 2015/472�� 17.2, 17.4 Companies (Cross-Border Mergers) Regulations 2007, SI 2007/2974�� 4.27, 4.39, 19.4, 19.8, 19.9, 19.11 Companies Limited Liability Partnerships and Partnerships (Amendment etc) (EU Exit) Regulations 2019, SI 2019/348 reg 5�� 4.39 Companies (Mergers and Divisions) Regulations 1987, SI 1987/1991�� 4.9, 4.14 Companies (Reduction of Share Capital) Order 2008, SI 2008/1915 art 3(3)(b)�� 25.6 Corporation Tax (Implementation of the Mergers Directive) Regulations 2007, SI 2007/3186�� 4.24, 9.21, 9.22, 20.3, 20.12, 27.23 Corporation Tax (Implementation of the Mergers Directive) Regulations 2008, SI 2008/1579�� 4.24, 9.21, 9.22, 20.3, 20.12, 20.28, 20.41, 20.58

Corporation Tax (Implementation of the Mergers Directive) Regulations 2009, SI 2009/2797�� 24.26 E European Public Limited-Liability Company (Amendment etc) (EU Exit) Regulations 2018, SI 2018/1298�� 4.37, 4.39 European Single Currency (Taxes) Regulations 1998, SI 1998/3177 reg 3�� 7.11, 7.12 T Taxation of Regulatory Capital Securities Regulations 2013, SI 2013/3209�� 9.4 reg 4�� 9.4 Tax Avoidance Schemes (Prescribed Description of Arrangements) Regulations 2006, SI 2006/1543�� 1.59 reg 5(1)(a)�� 1.59 Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) (Amendment) Regulations 2016, SI 2016/99�� 1.59 Taxes (Amendments) (EU Exit) Regulations 2019, SI 2019/689�� 20.1, 20.5, 20.9, 20.33, 20.41, 20.51, 26.1, 26.27, 26.32, 26.41, 26.52 Taxes (Amendments) (EU Exit) (No 2) Regulations 2019, SI 2019/818�� 26.3, 26.27

xxxi

Table of statutory instruments V Value Added Tax Regulations 1995, SI 1995/2518 reg 101�� 6.34, 8.24 reg 101(2)(e)�� 8.24 reg 101(3)(b)�� 8.24 reg 101(3)(e)�� 9.38 reg 101(8)�� 8.24, 9.38 reg 103B�� 8.24 reg 111�� 8.26, 8.27

Value Added Tax (Input Tax) (Specified Supplies) Order 1999, SI 1999/3121�� 3.5, 8.24, 9.38 Value Added Tax (Special Provisions) Order 1995, SI 1995/1268 art 5(1)–(2A)�� 3.5, 3.12, 8.30, 23.26 art 5(2B)�� 3.12 art 5(3)�� 3.5, 3.12, 8.30, 23.26

xxxii

Table of cases [All references are to paragraph numbers] A Abbey National plc v Customs & Excise Commrs (C-408/98) [2001] ECR I-1361, [2001] STC 297, ECJ�� 3.13, 3.14, 23.26, 26.64 Alabama New Oleans Texas & Pacific Junction Rly Co, Re [1891] 1 Ch 213, [1890] 12 WLUK 62�� 17.2 American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1978] STC 561�� 18.18 Anthony Hancock and Tracy Lee Hancock [2014] UKFTT 695 (TC)�� 9.10 Aveling Barford Ltd v Perion Ltd [1989] 4 WLUK 159, (1989) 5 BCC 677, [1989] BCLC 626�� 24.17 B BAA Ltd v Revenue & Customs Commrs [2011] STC 1791, UT, [2013] STC 752, CA�� 8.26 BLP Group Plc v Customs & Excise Commrs (C-4/94) [1995] ECR I-983, [1995] STC 424, ECJ�� 8.24 Banque Bruxelles Lambert SA v Belgium (C-8/03) [2004] ECR I-10157, [2004] STC 1643, ECJ�� 3.6 Barclays Mercantile Business Finance v Mawson 76 TC 446�� 1.67 Belgium v Ghent Coal Terminal NV (C-37/95) [1998] ECR I-1, [1998] STC 260, ECJ�� 8.26 Beteilgungsgesellschaft Larentia + Minerva mbH & Co.KG v Finanzamt Nordhausen (C-108/14 and C/109/14, [2015] STC 2101, ECJ�� 3.6, 8.26 British India Steam Navigation Co v IRC (1881) 7 QBD 165, [1881] 3 WLUK 70�� 6.6 Brooklands Selangor Holdings Ltd v Inland Revenue Commrs [1970] 2 All ER 76�� 15.4, 15.5, 15.6, 16.6, 16.11, 18.2, 22.2, 22.14 C C & E Commrs v Midland Bank Plc [2000] STC 501, ECJ�� 10.22 C & E Commrs v UBAF Bank Ltd [1996] STC 372, CA�� 8.26 Cibo Participations SA v Directeur régional des impôts du Nord-Pas-deCalais (C-16/00) [2001] ECR I-6663, [2002] STC 460, ECJ�� 3.6, 8.26 Coll v Commissioners for Revenue & Customs [2010] UKUT 114 (TCC)�� 13.17 Collector of Stamp Revenue v Arrowtown Investments Ltd [2003] HKCFA 46�� 1.67 Craven v White 62 TC 1�� 1.67, 8.21, 13.1, 13.4, 13.5, 13.23

xxxiii

Table of cases D Duke of Westminster v Inland Revenue Commrs 19 TC 490�� 13.10 Dunstan v Young, Austen & Young Ltd 61 TC 448�� 5.4, 5.5, 6.4, 6.6, 6.7, 6.8, 6.9, 6.10, 6.15, 6.21, 8.19, 24.18 Duomatic Ltd, Re [1969] 2 Ch 365, [1969] 2 WLR 114, [1969] 1 All ER 161�� 5.6 E EDI Services v Inland Revenue Commrs (No 2) [2006] STC (SCD) 392�� 1.67 Empresa de Desenvolvimento Mineiro SGPS SA (EDM) v Fazenda Pública (C-77/01) [2004] ECR I-4295, [2005] STC 65, ECJ�� 3.6 Euro Park Service v Ministre des Finances et des Comptes publics (Case C-14/16) [2017] 3 WLUK 195, [2017] 3 CMLR 17, [2017] BTC 5�� 26.57 European Commission v UK (C-86/11) ECLI:EU:C:2013:267, [2013] STC 2076, ECJ�� 3.11 F Fanfield Ltd (2011) TC 919�� 9.38 Finanzamt Offenbach am Main-Land v Faxworld Vorgründungsgesellschaft Peter Hünningshausen und Wolfgang Klein GbR (C-137/02) [2004] ECR I-5547, [2005] STC 1192, ECJ�� 8.26 Finn v HMRC [2015] UKFTT 144 (TC), [2015] 4 WLUK 122�� 12.3 Floor v Davies 52 TC 609�� 8.21, 13.1, 13.2, 13.3, 13.5 Floridienne SA v Belgian State (C-142/99) [2000] I-9567, [2000] STC 1044, ECJ�� 3.6 Furniss v Dawson 55 TC 324�� 1.67, 8.21, 13.1, 13.3, 13.5, 13.23 G Gallaher Ltd v R & C Commrs [2019] UKFTT 207 (TC)�� 1.9, 4.33 Gordon & Blair Ltd v Inland Revenue Commrs 40 TC 358�� 22.14 H HMRC v Investec Asset Finance plc [2018] UKUT 413 (TCC), [2018] 12 WLUK 580�� 1.46 HSBC Life v Stubbs (Inspector of Taxes) [2001] 11 WLUK 148, [2002] STC (SCD) 9, [2001] STI 1667�� 1.38 Halifax plc v C & E Commrs (Case C-255/02) [2006] Ch 387, [2006] 2 WLR 905, [2006] STC 919�� 8.25 Harding v HMRC [2008] EWCA Civ 1164, [2008] STC 3499, 79 TC 885, [2008] BTC 772, [2008] STI 2322�� 7.6, 9.9 Harding v [2013] UKUT 575 (TC), [2014] STC 891, [2013] 11 WLUK 425�� 14.14 Helvering v Gregory 69 F2d 809 (1934), affirmed 293 US 465 (1935)�� 1.67, 13.3 Hooper v Western Counties and South Wales Telephone Co Ltd [1892] 68 LT 78�� 5.2, 5.4, 15.3, 15.5, 15.6, 18.18, 22.14

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Table of cases I ICI v Colmer (C-264/96) [1998] ECR I-4695, 72 TC 1, ECJ�� 4.4 IRC v Addy 51 TC 71�� 13.16 IRC v Brebner 43 TC 705�� 13.8, 13.10, 13.11, 13.16 IRC v Clark 53 TC 482�� 13.8, 13.16 IRC v Duke of Westminster 19 TC 490�� 13.3 IRC v Gray [1994] STC 360�� 1.33 IRC v Greenberg 47 TC 240�� 1.57 IRC v Parker 43 TC 396�� 7.2 IRC v Scottish Provident Institution 76 TC 538�� 1.67 IRC v Sema Group Pension Scheme Trustees 74 TC 593�� 13.11 J JCM Beheer BV v Staatssecretaris van Financiën (C-124/07) [2008] ECR I-2101, [2008] STC 3360 ECJ�� 3.9 Joanne Elizabeth Fletcher v HMRC [2008] SpC 711�� 5.4, 6.15 K Klincke v HMRC [2010] STC 2032�� 7.6 Kretztechnik AG v Finanzamt Linz (C-465/03) [2005] ECR I-4357, [2005] STC 1118, ECJ�� 6.34, 7.19, 8.26, 17.10 L LM Tenancies v Inland Revenue Commrs [1996] STC 880�� 2.7, 10.21 Lazard v Rae 41 TC 1�� 25.1 Lewis (Trustee of Redrow Staff Pension Scheme) v Inland Revenue Commrs [1999] STC (SCD) 349�� 13.11 M MJP Media Services Ltd v HMRC [2010] UKFTT 298 (TC), [2010] 7 WLUK 15, [2010] SFTD 1083�� 1.38 MacNiven v Westmoreland Investments Ltd 73 TC 1�� 1.67 Marks & Spencer v Halsey (C-446/03) [2005] ECR I-10837�� 4.4 Marren v Ingles 54 TC 76�� 10.1, 10.9, 10.11, 10.17 Marwood Homes No 1 Ltd v Inland Revenue Commrs [1997] STC (SCD) 37�� 13.11 Marwood Homes No 3 Ltd v Inland Revenue Commrs [1999] STC (SCD) 44�� 13.11, 13.16 Mayes v HMRC [2011] STC 1269�� 1.67 Morgans Executors v Fellows 74 TC 232�� 15.6, 15.7, 16.1, 16.6, 16.11, 16.23, 18.18, 22.2 MyTravel Group, Re [2004] EWHC 2741 (Ch), [2005] 1 WLR 2365, [2004] 11 WLUK 652�� 17.5, 22.2 N NAP Holdings UK Ltd v Whittles 67 TC 166�� 5.5, 6.19, 8.14, 8.19 Nokes v Doncaster Amalgamated Collieries Ltd [1940] AC 1014, [1940] 3 All ER 549, [1940] 8 WLUK 4�� 19.9 Norseman Gold plc v Revenue and Customs Commrs [2016] STC 1276 (UT)�� 3.7 xxxv

Table of cases O O’Rourke v Binks 65 TC 165�� 7.10 P PA Holdings v HMRC [2011] EWCA CIV 1414�� 1.67 Palace Hotel, Re [1912] 2 Ch 438�� 5.2 Polysar Investments Netherlands BV v Inspecteur der Invoerrechten en Accijnzen (C-60/90) [1991] ECR I-3111, [1993] STC 222, ECJ�� 3.6 S Salomon v Salomon and Co [1897] AC 22�� 1.2 Savoy Hotel Ltd, Re [1981] Ch 351, [1981] 3 WLR 441, [1981] 3 All ER 646�� 17.2 Schweppes Ltd, Re [1914] 1 Ch 322�� 5.2 Securenta Göttinger v Finanzamt Göttingen (C-437/06) [2008] ECR I-1597, [2008] STC 3473, ECJ�� 8.26 Sevic Systems AG (Case C-411/03) [2005] ECR I-10805�� 4.26 Six Continents Ltd v IRC [2016] EWHC 2426 (Ch), [2017] STC 1228, [2016] 10 WLUK 69�� 1.26 Skatteverket v AB SKF (C-101/05) [2007] ECR I-11531, [2010] STC 419, ECJ�� 3.6, 3.11, 6.33, 8.24, 8.25 Snell v HMRC [2006] All ER (D) 336�� 13.12, 13.15, 14.14 South African Supply and Cold Storage Co, Re [1904] 2 Ch 268�� 15.3, 15.4, 15.5, 15.6, 16.1, 16.2, 16.11, 16.13, 17.5, 18.2, 18.18, 19.3, 19.5, 22.2, 22.14 Staatssecretaris van Financien v X BV (C-651/11) ECLI:EU:C:2013:346, [2013] STC 1893, ECJ�� 3.14 Strand Futures and Options Ltd v Vojak 76 TC 220�� 6.29 Swithland Investments Ltd v IRC [1990] STC 448, [1990] 4 WLUK 204�� 19.3 T T & N Ltd, Re [2006] EWHC 1447 (Ch), [2007] 1 All ER 851, [2007] Bus LR 1411�� 17.2 TSB Nuclear Energy Investment UK Ltd, Re [2014] EWHC 1272 (Ch)�� 19.9, 19.23 Trevor G Lloyd v HMRC SpC 672�� 13.8, 13.11 Trigg v R & C Commrs [2014] UKFTT 967 (TC), [2014] 10 WLUK 586, [2015] SFTD 142�� 9.5 U Underground Electric Railways Co of London Ltd v Inland Revenue Commrs [1905] 1 KB 174, [1906] AC 21�� 2.7, 10.21 Underground Electric Railways Co of London Ltd v Inland Revenue Commrs [1914] 3 KB 210�� 2.7, 10.21 Unilever (UK) Holdings Ltd v Smith 76 TC 300�� 5.4, 6.4, 6.6, 6.7, 6.15, 6.17

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Table of cases V Vinton and another (executors of Dugan-Chapman (deceased)) v Revenue and Customs Commrs [2008] SpC 666�� 5.6, 6.11, 6.15 Vodafone 2 v HMRC [2009] STC 1480�� 4.4, 26.26 W WT Ramsay Ltd v Inland Revenue Commrs 54 TC 101�� 1.56, 1.57, 1.67, 1.68, 13.1, 13.2, 13.3, 13.4, 13.5 Walker’s Settlement, Re; Royal Exchange Assurance Corpn v Walker [1935] Ch 567, [1935] 4 WLUK 26�� 19.3 Water Hal Group plc [2002] STI 1801�� 8.25 Wellcome Trust Ltd v Customs & Excise Commrs (C-155/94) [1996] ECR I-3013, [1996] STC 945, ECJ�� 3.6 Westcott v Woolcombers Ltd, 60 TC 575�� 8.13, 8.14, 8.19 Williams v Singer [1921] 1 AC 65�� 7.2 Wood Preservation Ltd v Prior [1968] 2 All ER 849�� 2.9

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Part 1

Fundamentals of corporation tax

2

Chapter 1

Corporation tax and chargeable gains

INTRODUCTION1 1.1 For the first 100 years or so of the current system of taxation in the UK, there was no special tax regime for companies and no taxation of gains on capital assets. However, both corporation tax and capital gains tax were introduced in the Finance Act 1965 (‘FA 1965’), representing one of the most fundamental reforms of the UK’s tax system ever.

1 The source of much of this introductory material is the Inland Revenue’s History of the Finance Act 1965 by R I McConnachie and E McGivern.

CORPORATION TAX 1.2 When income tax was first introduced, originally in 1799, then again in 1842 after its repeal in 18161, it was only imposed on individuals, because there was no clear distinction between a company and its members. Indeed, the modern concept of a company, being an incorporated body distinct from its members, and whose members had only limited liability in respect of the company, did not fully mature until the Companies Act 1862 (‘CA 1862’)2. Before that, the income of a company was considered to be effectively the income of the members, much like a modern partnership. What is more, the concept of a company as an entity in its own right was not finally established until the case of Salomon v Salomon and Co [1897] AC 22. Once the concept of a company had become established, however, it did not take long for the taxing authorities to recognise the distinction and introduce differences between companies and individuals. In World War I, excess profits duty was temporarily imposed on companies’ profits, in addition to income tax, and companies were also charged to corporation profits tax from 1920 to 1924, to the national defence contribution from 1937 and to profits tax from 1946. Over the decade from 1955, a specific corporation tax was considered on various occasions. Several attempts foundered on the pressures on successive 3

1.3 Corporation tax and chargeable gains Finance Bills or because of changes of government and hence of policy. Finally, the tax was enacted in FA 1965. Under the income tax regime that applied to companies until 1965, a company was effectively not taxed on distributed profits, and the shareholder paid income tax on the distributions received. A great deal of the debate in formulating the new corporation tax was about whether a mechanism should be found to avoid economic double taxation3, once on the company’s profits and again when the post-tax profits were paid out to shareholders, or whether such double taxation was, instead, a desirable method to encourage the retention of profits within the corporate sector to encourage investment. In fact, when the tax was first introduced in 1965, no credit was given for the tax already borne by a company on the profits out of which dividends were paid. This was a deliberate attempt to encourage companies to reinvest their profits into the business, rather than to distribute profits to the shareholders. Of course, the converse effect was also seen, in that the tax barrier to distributions acted as a discouragement to investment, making it harder for companies to raise capital. It is important to remember that the capital gains tax was introduced in a Finance Act that was geared towards discouraging distributions out of the corporate sector and realisations of capital gains derived from the increasing value of shares in the corporate sector. When the Conservative Party came to power in 1970, a desire to correct what was considered to be a discouragement to enterprise led to the introduction of an imputation system in 1973.

1 Ignoring what was effectively only a temporary repeal in 1802. 2 Prior to the Companies Act 1862, there were ‘deed of settlement’ companies. These companies were unincorporated associations, the various shareholders of which formed a deed of settlement with a trustee declaring that the persons holding shares constituted a company, setting out the characteristics of the company and declaring that the shares in that company were transferable. Prior to this, shares had not been transferable. Later, joint stock companies came into existence (pursuant to the Joint Stock Companies Act 1844). The members of a joint stock company, however, were still liable for the debts and liabilities of the joint stock company as if they were partners in a partnership. The Limited Liability Act of 1855 introduced the concept of the liability for members being limited to the nominal amount of the share capital which they held, but limited liability was subject to a number of conditions. The Limited Liability Act 1844 was consolidated by the Joint Stock Companies Act 1856 and this Act revolutionised company law by simplifying the previously complex incorporation procedure and by allowing limited liability. The Joint Stock Companies Act 1856 was consolidated with a number of other Acts into the Companies Act 1862. 3 The choice was between an exemption method, which taxed a company’s profits but exempted dividends from income tax in the shareholders’ hands, and an imputation method, whereby shareholders were given a credit for the tax already paid by the company.

TAXATION OF CAPITAL GAINS 1.3 A tax on gains was first looked at by a 1920 Royal Commission, although the main result was that a number of tax cases were taken through the 4

Corporation tax and chargeable gains 1.4 courts to see how far speculative transactions could be taxed under the income tax provisions. Readers familiar with the field might speculate that these transactions may have involved toilet rolls, aeroplane dope or whisky! The development of a tax on capital gains started in earnest after World War II when a fast-growing economy meant that there was considerable scope for tax-free profits from speculation in stocks and shares. This suggested that a person’s income was not necessarily an adequate measure of their ‘taxable capacity’. In the words of the Inland Revenue’s history of FA 1965, ‘the sophisticated economics of the mid-twentieth century demanded a broader base for the tax system’. In a sense, the introduction of a tax on chargeable gains can be seen as an anti-avoidance measure, too. Many of the tax avoidance schemes that were devised in the 1950s and early 1960s were designed to ensure that receipts were capital in nature, not income. While the introduction of the transactions in securities legislation in FA 1960 (which is still with us as ITA 2007, s 682 et seq and CTA 2010, s 731 et seq) went some way to countering these abuses, a tax on chargeable gains was thought to be the death knell for such ‘income into capital’ schemes. Of course, this is only true if the tax rates on gains and income are the same. For a large part of the 50 plus years since the introduction of capital gains tax, the rate of tax on gains has been materially less than that on income, so tax planning in this area is still seen as worthwhile. Indeed, the conversion of income into capital or amounts taxed at a lower rate remains a concern of tax authorities in the 21st century and has its own hallmark under the mandatory disclosure rules introduced in 2018 and effective in the EU (and the UK) under DAC6 from 1 July 2020. In its 20-year gestation, the capital gains tax was resisted by the Inland Revenue largely because of staffing difficulties, and a 1955 Royal Commission opposed it on the grounds of complexity, arbitrariness and uncertainty of yield. From the mid-1950s onwards, the concept of a capital gains tax was something of a political weapon: with high inflation, trades unions might be persuaded to agree to wage restraint if the wealthy were taxed on their hitherto tax-free capital gains. Eventually, the short-term gains legislation was introduced in FA 1962, charging income tax on gains realised within six months on most assets, and within three years on land, and the full capital gains tax was introduced alongside the new corporation tax in 1965. The 1965 legislation, as we shall see, re-used a great deal of the 1962 legislation.

CONCLUSION 1.4 The new taxes expressed a political philosophy of taxation that, at the time of its introduction, amounted to a coherent body of taxation policy. In this context, the relevant provisions regarding the taxation of corporate reorganisations should be regarded as a system under which various forms 5

1.5 Corporation tax and chargeable gains of corporate restructurings that were legitimate commercial activities and therefore of benefit to the economy are deemed to be tax-free, despite the fact that they involve disposals of assets, because they do not involve the contravention of the overriding principle that value should not be extracted from the corporate body in a way that avoids tax. What is interesting, however, is that the exemptions for reorganisations and reconstructions that were built into both the 1962 and 1965 legislation were not discussed in the Inland Revenue’s history at all.

BASIC RULES OF CORPORATION TAX 1.5 To understand the taxation of company reorganisations, it is helpful to begin by stating certain basic principles that underlie UK corporation tax: ●●

companies are charged to corporation tax on their ‘profits’ for any financial year, generally on an individual entity basis, as separate legal persons;

●●

for these purposes, ‘profits’ means the income and gains of UK resident companies, wherever arising (subject to double tax relief by way of credit or exemption), with income being computed on income tax principles and chargeable gains on capital gains tax principles;

●●

capital gains are taxable on a realisations basis (unlike income which is broadly taxable on an accounting accruals basis), subject to various reliefs that have accumulated over time which are designed to encourage certain forms of business activity;

●●

where companies form a group, there are rules under both the income tax and capital tax principles (as applied to companies) that can permit the group to be treated as if it were to some extent a single entity. For example (and subject to new loss restriction provisions), trading and other income losses can be transferred within a group and capital assets, gains and losses can be transferred between UK group companies on a tax-free basis with the gain on a transferred asset accruing only when the asset is sold outside the group; and

●●

notwithstanding the general rule that the profits of a UK tax resident company are subject to UK corporation tax wherever they arise, the territorial scope of UK corporation tax is generally limited to activities carried out in the UK or the profits attributable to UK branches of overseas tax resident companies. This is achieved through a combination of reliefs and exemptions, such as double taxation relief, the distributions exemption and the substantial shareholding exemption.

To set the scene for our description of the taxation of company reorganisations, we will begin by describing the basic framework for the taxation of capital 6

Corporation tax and chargeable gains 1.7 gains of companies, usually referred to as ‘chargeable gains’. We will then describe the rules relating to capital losses and group relationships. This will be followed by a summary of the substantial shareholding exemption.

TAXATION OF CAPITAL GAINS 1.6 Taxation of capital gains was originally introduced in 1962 in the form of an income tax on short-term gains. This was essentially a tax that was created to prevent what was deemed by the government of the day to be a socially unacceptable way of avoiding tax on a form of wealth realisation. The framework of this tax was then used in 1965 as the basis for a new general tax on capital gains and much of the 1962 drafting was appropriated for these purposes. The key concepts of capital gains tax as they were first stated in 1965 were essentially to tax a person (an individual, a company or any other taxable entity) on the increase in value of an asset between the date of acquisition and the date of disposal. These concepts obviously required numerous definitions to set out their scope and application. For example, some kinds of assets are not caught by capital gains tax, ie are not ‘chargeable assets’, such as money, medals or certain chattels; some persons are not chargeable to the tax, such as exempt pension funds; some disposals do not carry an immediate tax charge, such as disposals within a group of companies and certain transactions of reorganisation or reconstruction. It is these latter transactions that are the subject of this book. Furthermore, there are reliefs from taxation in relation to the period of ownership, such as indexation relief for companies (which was repealed with effect from 31 December 2017); for the way in which the consideration proceeds are used, such as roll-over and hold-over reliefs for the replacement of business assets; and even for the type of disposal, such as the reliefs for gifts of assets, for dispositions on death and for transfers to spouses.

Allowable losses 1.7 Capital losses (referred to as ‘allowable losses’) arise in the same way as chargeable gains, if the consideration received (as adjusted for incidental costs of disposal) is less than the original base cost (as adjusted by the allowable cost of acquisition and the indexation allowance for companies to 31 December 2017). An important point to note is that the indexation allowance cannot increase the size of an allowable loss or turn an otherwise chargeable gain into an allowable loss. In FA 2006, Parliament enacted a series of rules designed to prevent abuse of the capital loss rules for companies. In doing so, HMRC also stated 7

1.7 Corporation tax and chargeable gains what it sees as the three main principles governing the creation and use of capital losses1: ●●

relief for capital losses should only be available where a group or company has suffered a genuine commercial loss and made a real commercial disposal;

●●

unless there is a continuation of a trade and certain detailed conditions apply, relief for a company’s capital losses should only be available against its own capital gains or those of companies that were under the same economic ownership, both when the capital loss was accrued and when the capital loss is utilised; and

●●

except in certain restricted circumstances, capital loss relief is only available against capital gains, not income profits.

The new rules enacted were designed to prevent abuse in each of a number of areas: the artificial creation of losses where there was no real disposal, loss buying and gain washing schemes and schemes designed to generate income relief from capital assets. More important than the targeting of these new rules was this very clear and explicit statement of policy, although specific rules to target some of the schemes had been enacted in earlier Finance Acts (such as the anti-loss buying rules of Taxation of Chargeable Gains Act 1992 (‘TCGA 1992’), Sch 7A in FA 1993 and the anti-gain washing rule of TCGA 1992, Sch 7AA in FA 1998). All these rules are examples of the legislation being changed to close down what was seen as offensive use of the tax rules for purposes other than those intended by Parliament. Allowable losses accruing in an accounting period can be deducted from chargeable gains that arise in the same accounting period or later (TCGA 1992, s 2A), but they cannot be carried back to shelter earlier chargeable gains (TCGA 1992, s 1E(7))2. Although capital losses cannot be surrendered within a group, there is an election available to give effect to the policy that ‘a company’s capital losses should only be available against its own capital gains or those of companies that were under the same economic ownership’. If a company wants to sell an asset at a gain and another company in the group has an allowable loss (either current period or carried-forward), an election under TCGA 1992, s 171A permits the two companies to elect that the gain (or any part of it) be deemed to accrue the company with the loss. Similarly, if a company were to sell an asset at a loss and another group company is expecting to realise a gain (in that period or a subsequent period), an election under TCGA 1992, s 171A permits the two companies to transfer that loss to the company that will make the gain. This has the same effect as

8

Corporation tax and chargeable gains 1.8 transferring the asset itself on a ‘no gain no loss’ basis (see 1.8 et seq below) under TCGA 1992, s 171 immediately prior to the sale to a third party. Finance Act 2020 introduced new rules for the relief of corporate capital losses from 1 April 2020. This extends the corporate income loss restriction introduced in April 2017 to include carried-forward capital losses. Under the rules, companies making capital gains will only be able to use carried-forward capital losses to offset up to 50 per cent of those gains.

1 Paragraph 10 of HMRC Guidance, ‘Avoidance through the creation and use of capital losses by companies’ published on the HMRC website on 5 December 2006 with the pre-Budget report material. 2 FA 2019 included a rewrite to TCGA 1992, Pt 1 which sets out the basic principles of capital gains tax and corporation tax on chargeable gains.

GROUP RELATIONSHIP RULES 1.8 As mentioned above, many transactions within a group are deemed to be tax-free in one way or another, but this means we have to know what a group is for the purposes of determining whether the reliefs apply. In the case of capital gains, such a group consists of the principal company, its 75 per cent subsidiaries, the 75 per cent subsidiaries of those subsidiaries and so on (TCGA 1992, s 170(3)(a)). Additionally, all 75 per cent subsidiaries must be effective 51 per cent subsidiaries (TCGA 1992, s 170(3)(b)). Finally, a company can only be a member of one group. Notably, there is no requirement for a company to be UK tax resident or have a UK permanent establishment to be a member of a capital gains group. A 75 per cent subsidiary is a company 75 per cent or more of whose share capital is owned directly or indirectly by the principal company (CTA 2010, s 1154(3)). To be an effective 51 per cent subsidiary, the principal company must ultimately be entitled to more than 50 per cent of the economic value of the group member – dividends, profits available for distribution or assets on a winding up (TCGA 1992, s 170(7)). These tests appear in various forms in several places throughout the Taxes Acts. It is an example of the way that tests found to work in one context have been adapted to many different uses over time. The capital gains group definition has also been ‘recycled’ in other parts of the Taxes Acts, most notably in the loan relationship provisions in CTA 2009, Part 5. Similarly, the anti-avoidance provisions of CTA 2010, Part 5, Chapter 6 are used to prevent abuse of the capital gains grouping rules, having themselves been originally enacted to prevent abuse of the group relief rules for corporate 9

1.9 Corporation tax and chargeable gains income losses. These same rules are also used in a number of other contexts throughout the Taxes Acts. Transfers of assets within a capital gains tax group do not crystallise chargeable gains (TCGA 1992, s 171), but are instead deemed to occur at a value that gives neither a gain nor a loss for tax purposes, ie in practice, cost plus indexation allowance (as adjusted by incidental costs of acquisition). This has the effect that any gain since an asset came into a group is only taxed when the asset leaves the group, a relief which has innumerable commercial uses.

The Gallaher case 1.9 The First Tier Tribunal case of Gallaher Ltd v Revenue and Customs Commissioners [2019] UKFTT 207 (TC) considered whether the requirement in TCGA 1992, s 171 (and the intangible fixed assets equivalent in CTA 2009, s 775) that the transferee needs to be within the charge to UK corporation tax could be considered an unjustifiable infringement of the EU freedom of establishment. The key point here is that, where a transfer by a UK corporation tax payer is between connected persons, the consideration is deemed to be at fair market value under TCGA 1992, s 17, but if the transferee is subject to UK corporation tax, TCGA 1992, s 171 provides for tax neutrality (and ultimate deferral). This could be argued to discriminate against companies resident in EU Member States other than the UK (before Brexit). In Gallaher, the taxpayer was not contending that the relevant group transfer rules should simply apply to the taxpayer in the same way as they would have done if the transferee had been within the scope of UK corporation tax, but that these provisions should allow for a deferral of the UK corporation tax liability in the circumstances of the relevant disposal. Broadly, the Tribunal agreed with this assertion. However, the Tribunal found that the restriction was justified since it secured the balanced allocation of taxing powers between Member States. Nevertheless, in the disapplication of TCGA 1992, s 171 requiring the tax in question to be paid immediately, the Tribunal concluded that the restriction goes further than is ‘proportionate’ and that the restriction would have been proportionate if it were to provide for the tax in question to be paid in instalments. The Tribunal felt that it was not within its competence or remit to remedy the existing restriction and therefore held that it was necessary to disapply the existing exclusion from TCGA 1992, s 171. At the time of the judgment, this was seen as a potentially interesting outcome, since it opened the possibility for UK companies to transfer assets to an entity resident in an EU Member State without triggering an immediate tax charge. This was particularly timely, given that many groups were in the midst of their Brexit planning. 10

Corporation tax and chargeable gains 1.10 That said, given that the effect of the judgment was a broader disapplication of TCGA 1992, s 171 rather than the introduction of tax deferral provisions, it was likely that HMRC would have appealed the decision so, in practice, it would have been unlikely for taxpayers to be able to file on the basis of Gallaher without adequate provisioning in place. Finance Act 2020, Sch 7 introduced tax deferral provisions in respect of the transfer of assets (including chargeable assets and chargeable intangible assets) within the same group, which effectively result in these provisions now having a proportionate restriction, since the tax in question can be paid in instalments. These provisions are deemed to have come into force on 11 July 2019 and have effect in relation to accounting periods ending on or after 10 October 2018. Therefore, whilst still potentially relevant, the Gallaher case is not likely to open the door for UK companies to transfer assets to an entity resident in an EU Member State on a tax-neutral basis, but it should be possible to avoid the triggering of an immediate tax charge as a result of the deferral provisions introduced by Finance Act 2020.

THE DEGROUPING CHARGE 1.10 The relief on group transfers is also potentially open to abuse. A simple example of this was the so-called ‘envelope trick’, whereby an asset with low base cost was transferred into a company with high base cost and the company was then sold (see Figure 1.1), so sheltering the gain on the asset. Essentially, the hive-down of the asset means that the New Co has a market value equal to the base cost of the asset transferred to it. When New Co is sold, there is therefore no chargeable gain, as the consideration paid for New Co equals Company A’s market value base cost in the shares of New Co. Figure 1.1 The envelope trick

11

1.11 Corporation tax and chargeable gains As a result, we have anti-avoidance legislation in TCGA 1992, s 179 which deems the sheltered gain to crystallise if the transferee company leaves the group within six years of the transfer. This is achieved by computing the gain that would have accrued had the transferee company (eg New Co) sold the asset at the market value when the asset was transferred to it (effectively by deeming New Co to have sold and immediately reacquired the asset at that value). In most cases, the degrouping arises from a disposal of the shares of the subsidiary (called ‘the group disposal’, TCGA 1992, s 179(3B)), as in the sale of New Co in Figure 1.1. Following changes introduced by FA 2011, in such cases the gain on the degrouped asset is added to the consideration for the vendor’s sale of the shares. In Figure 1.1, therefore, while there is no net gain on the disposal of the shares of New Co – the gain on the deemed disposal is then added to the proceeds of the share sale by Company A, giving the same gain that Company A would have suffered if it had merely sold the asset directly. This anti-avoidance rule has no motive test, so it applies even if there is an innocent intra-group transfer and an equally innocent commercial disposal of the transferee company. However, because the gain is added to the consideration received by the vendor company, any exemptions or reliefs from corporation tax on chargeable gains that apply to the group disposal will also apply to the degrouping element. For example, if the substantial shareholding exemption (see 1.11 et seq below) applied to the disposal of New Co by Company A, then that exemption would also apply to the degrouping element of the gain. Furthermore, TCGA 1992, s 179ZA permits an adjustment to prevent double taxation, if such an adjustment would be ‘just and reasonable’.

SUBSTANTIAL SHAREHOLDING EXEMPTION 1.11 Over the two years or so prior to the enactment of FA 2002, the Inland Revenue entered into consultation about the possibility of deferring or exempting gains arising when trading groups disposed of trading subsidiaries or sub-groups. This was intended to make the UK a more attractive place for groups to establish themselves, given that many other countries had exemptions from gains for such disposals (such as the Dutch participation exemption, which has also been adopted in other EEA jurisdictions since). The result was the enactment of TCGA 1992, Sch 7AC in FA 2002, the substantial shareholding exemption (‘SSE’), which represents a fundamental change in the system of taxation of chargeable gains in the UK. F(No 2)A 2017 introduced reforms to the SSE which apply to disposals on or after 1 April 2017. 12

Corporation tax and chargeable gains 1.13

The relief 1.12 Following the changes in 2007, the substantial shareholding exemption essentially provides that a gain crystallised by a company on the disposal of shares or an interest in shares after 1 April 2002 would normally be exempt from corporation tax on chargeable gains, so long as the vendor holds a minimum 10 per cent shareholding for at least 12 months during the last six years immediately preceding the date of disposal and is selling a trading company or sub-group. The legislation also provides that, where a loss arises in circumstances where a gain would have been exempt, that loss is not an allowable loss. Where the requirements of the SSE apply, the exemption applies automatically. There are specific qualifying criteria that must be met in order to benefit from this valuable exemption. These are: ●●

the substantial shareholding requirement; and

●●

the requirement relating to the company being sold (‘the company invested in’).

The essence of the relief is that, if a UK tax resident company sells a trading subsidiary or sub-group, the gain is exempt from any taxation of any chargeable gains that might otherwise arise. For all other purposes, however, the transaction is still a disposal for capital gains purposes. One of the fundamental changes introduced by F(No 2)A 2017 is the removal of the requirements to be met by the investing company.

The substantial shareholding requirement 1.13 The substantial shareholding requirement (TCGA 1992, Sch 7AC, Pt 2) is satisfied if the investing company: ●●

holds at least 10 per cent of the ordinary share capital of the company invested in;

●●

is beneficially entitled to at least 10 per cent of the profits available for distribution of the company invested in; and

●●

is beneficially entitled to at least 10 per cent of the assets of the company invested in which are available to equity holders on a winding up.

CTA 2010, Part 5, Chapter 6 is to be used in interpreting these measures. Again, readers will recognise that these tests are adapted from earlier uses in the Taxes Acts (see, for example, the discussion of what constitutes a group of companies for capital gains tax purposes). 13

1.13 Corporation tax and chargeable gains The three qualifying conditions must have been satisfied for a continuous period of at least 12 months during the six years immediately preceding the date of disposal and the holdings of all group companies may be aggregated. If the disposing company (or another group company) acquired the shares through a no gain/no loss transfer (or what would have been such a transfer if TCGA 1992, s 127 or 135 had not applied), the ownership period of the disposing company and the company from which the shares were acquired may be aggregated. This also extends to situations where the shares disposed of are not the same as those that were acquired (such as following a reorganisation under TCGA 1992, s 127) and also where there has been a reorganisation, reconstruction or a demerger. This does not, however, extend to situations where there has been a deemed disposal and reacquisition of the shareholding (such as a degrouping event within TCGA 1992, s 179). The period prior to the deemed disposal and reacquisition cannot form part of the aggregated qualifying holding period. That said, the degrouping event itself may be subject to the exemption (see next paragraph). The substantial shareholding exemption also applies to deemed disposals. This might be relevant where shares are deemed to be disposed of and immediately reacquired, such as on a claim for negligible value (TCGA 1992, s 24) or where there is a degrouping event involving shares that were previously the subject of an intra-group transfer. The extension of the ‘look-back’ period from two years to six years introduced by F(No 2)A 2017 will generally be helpful, since it allows the exemption to apply to the sale of a residual shareholding in a company that has been delayed by circumstances outside a company’s control that would not have otherwise qualified for the SSE. However, the counter-effect to this is where a company is expecting to realise a loss on the disposal of shares and would have otherwise delayed the sale of a rump shareholding until the point at which the substantial shareholding requirement is no longer satisfied. The company will now have to wait an extra 4 years to be able to do so! This may be a minor effect, however, given the restriction on capital loss creation in ‘disqualifying circumstances’ (TCGA 1992, s 16A). FA 2011 introduced an exception to the normal rule, where a company is selling a trade and does so by transferring assets used as part of its trade to another member of the same group the shares of which are subsequently sold. This could be by way of a hiving down of assets to a new shareholding (see Figure 1.2). In this case, if the rest of the conditions for the substantial shareholding exemption are satisfied, Company B is treated as having held the shares in New Trader for as long as the assets of the trade had been in use for the purposes 14

Corporation tax and chargeable gains 1.13 of trades carried on by Company B or any other member of the same group (TCGA 1992, Sch 7AC, para 15A). This means that the degrouping charge, which arises in respect of the assets transferred to New Trader, could be exempt, too, as it is merely added to the consideration received by Company B for the exempt disposal. The requirements to be met by the company invested in have also been amended to accommodate this change (see below). Figure 1.2 ‘Packaging’ a trade

An important caveat here, though, is that the FA 2011 changes only apply where the assets concerned are chargeable assets, subject to the chargeable gains legislation. There are similar degrouping charges (in CTA 2009, Pt 8) in respect of intangible fixed assets which apply the charge to the company leaving the group, and the FA 2011 changes did not include these. In Figure 1.2, this means that there might still be a degrouping charge in New Trader in respect of the goodwill of the trade transferred from Company B. This was an unfortunate consequence of poor tax policy making, as the original policy behind the taxation of corporate intangibles, introduced in FA 2002, was that rules should largely mirror those for tangible assets. However, FA 2019 introduced a change to CTA 2009, Pt 8 which disapplies the degrouping charge under CTA 2009, s 780 where a company ceases to be a member of a group because of a ‘relevant disposal’ of shares by another company (CTA 2009, s 782A). For these purposes, a disposal of shares is ‘relevant’ if the gain on these shares qualifies for SSE and there is no arrangement under which the recipient is to dispose of these shares to another person. The mechanism for this relief is therefore different to the FA 2011 changes, since the deferred gain is not treated as part of the consideration of the shares (as is the case in TCGA 1992, s 179(3B)) but rather, the degrouping rule in CTA 2009, s 780 is disapplied in its entirety upon the meeting of certain conditions. The side effect, of course, is that chargeable assets are rebased for 15

1.14 Corporation tax and chargeable gains capital gains purposes, by virtue of the deemed disposal and reacquisition, but chargeable intangible assets are not, as the deemed disposal rule is simply not applied.

Requirements to be met by the investing company 1.14 For disposals made prior to 1 April 2017, there were requirements to be met by the investing company and, broadly, these were that it must either be a sole trading company or a member of a trading group throughout the period beginning with the start of the latest 12-month period by which the substantial shareholding requirement is met and ending with the time of disposal. It also had to be either a sole trading company or a member of a trading group immediately after the time of disposal. For a disposal under a conditional contract whereby the date of disposal for tax purposes precedes the date of transfer of legal ownership, this requirement had to be met at both times. Following a consultation in 2016 on the reform of SSE, one of the key changes was the repeal of the requirements to be met by the investing company. Broadly, this means that the investor company need not be a trading company or member of a trading group for disposals on or after 1 April 2017. This is a welcome change as it should now result in more commercial disposals being within the scope of the exemption. For example, a common flaw in the predecessor provisions was that a holding company was unable to qualify for the exemption on the disposal of its last trading subsidiary as it no longer met the ‘immediately after’ test.

Requirements to be met by the company invested in 1.15 The company being sold (the company invested in, as the legislation succinctly refers to it) must also be either a trading company or a holding company of a trading group or sub-group for the same period as that applying to its parent company. What is meant by trading? 1.16 A trading company or group is defined as a company or group whose activities (taken together, in the group context) do not include to a ‘substantial’ extent activities other than trading activities. Whilst ‘substantial’ is not defined in this context, HMRC has advised that the group as a whole should be inspected to see whether there is non-trading activity. If there is, then HMRC suggests that ‘substantial’ means ‘more than 20 per cent’. This can, however, apply to almost any financial and non-financial measure, including assets, turnover, profits and management time. However, HMRC has said, in consultation, that 16

Corporation tax and chargeable gains 1.17 the 20 per cent measure is neither a test nor a safe harbour, and is not to be applied mechanically. Instead, these are guidelines to help determine whether the group or company is a trader, as defined. Trading activities are also taken to include any activities carried on by a company in relation to a trade carried on by it, in preparation to carry on trade, with a view to commencing or acquiring a trade or with a view to acquiring 51 per cent of a trading company or between 10 and 50 per cent of a joint venture. Any intra-group activities are ignored when considering whether a group is a trading group. This does not apply, however, to any activities between a member of a sub-group being sold and any group company outside of that sub-group. Additional care needs to be taken where there are, for example, intra-group loans or leases. In the authors’ view, the best guidance in this area was that which applied for taper relief purposes in Tax Bulletin 53, which can still be found in the online archives (http://webarchive.nationalarchives.gov.uk/20110620155444/http://hmrc. gov.uk/bulletins/tb53.pdf). HMRC’s Manual at CG53116 et seq. give the official guidance for inspectors in this area but are somewhat dogmatic in their approach (saying, for example, that ‘substantial’ means more than 20 per cent, a statement with no basis in statute or jurisprudence). Transfer of trading assets 1.17 The FA 2011 changes, referred to in 1.13 above, also apply here to extend the period during which a new trading subsidiary is deemed to have been trading in respect of trading assets transferred to it (TCGA 1992, Sch 7AC, para 19(2B)). So (using the facts of Figure 1.2) New Trader is treated as being a ‘trading company’ for the purposes of this requirement for as long as the assets of the trade had been in use for the purposes of trades carried on by Company B or any other member of the same group (with cross-references to TCGA 1992, Sch 7AC, para 15A(2)(b)–(d)). This is necessary to ensure that the substantial shareholding exemption can apply to the disposal of ‘packaged’ trades, as otherwise New Trader would not have been a trading company for the requisite 12-month period. The circumstances in which the trading extension applies is limited and in particular, does not apply to circumstances where a trading asset is transferred to a subsidiary of the company invested in. This is because the requirement in TCGA 1992, Sch 7AC, para 15A(2)(b) requires that, at the time of disposal, the asset is used for the purposes of a trade carried on by the company invested in itself, rather than a member of the trading group of which the company invested in is the holding company. This is also supported by the use of the words ‘trading company’ rather than ‘qualifying company’ in TCGA 1992, Sch 7AC,

17

1.18 Corporation tax and chargeable gains para 19(2B). This is notwithstanding the initial consultation document and, indeed, HMRC manuals insouciantly using the phrase ‘qualifying company’. This interpretation appears to be consistent with the intention of the Parliamentary draftsman. Documents from the time this change was introduced described the proposal being relevant to circumstances in which assets that have been used for the purposes of a trade by the group are subsequently transferred to a newly incorporated company that continues to use the same assets for the purposes of a trade1. In recent years, as UK groups consider the impact of Brexit on their operations, a common tax question is whether the disposal of shares in a new ‘EU hub’ company to which a trading permanent establishment has been transferred could qualify for SSE? Provided there is the transfer of a trading asset as part of the permanent establishment and the requirements of TCGA 1992, Sch 7AC, para 15A(2)(b)–(d) have been met, this is possible. There is, however, a distinction between a ‘trade’ and a ‘business’, with the latter required in order to meet the OECD definition of a ‘permanent establishment’. Therefore, it is possible that a group of assets are sufficient to constitute a ‘business’ and therefore a permanent establishment, but that the trading test is not met.

1 For example, paragraph 4.7 of the joint HM Treasury and HMRC document titled ‘Simplification review: capital gains rules for groups of companies – a consultation document’ of 3 February 2010.

Recent reform of SSE 1.18 F(No 2)A 2017 also restricted the requirement for the trading condition to be met immediately following the disposal to circumstances where the vendor and purchaser are connected or the substantial shareholding requirement is met by virtue of TCGA 1992, Sch 7AC, para 15A.

Definition of a group for SSE 1.19 The definition of a group for the purposes of the substantial shareholding exemption is identical to that for a capital gains group, except that the 75 per cent subsidiary requirement is replaced by the lesser test of being a 51 per cent subsidiary (and an effective 51 per cent subsidiary) for the substantial shareholding exemption. This is another adaptation of a by now very familiar test.

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Corporation tax and chargeable gains 1.21 On this basis, a holding of less than 51 per cent in a joint venture company would not qualify prima facie as part of the group for these purposes and the holding of shares is not itself considered to be a trading activity, such that if a shareholding in a joint venture company represents a substantial proportion of the investing company or group’s assets, that holding could taint the trading status of the investing company or group. Special rules apply, therefore, where a company has a qualifying shareholding in a joint venture. A company is a joint venture for this purpose only if it is a trading company or a holding company of a trading group or sub-group and there are five or fewer investors who between them own 75 per cent or more of its ordinary share capital. The activities of a joint venture company are then deemed to be part of the activities of the company holding the shares in that joint venture company with the extent of those activities being apportioned on the basis of the shareholdings.

Extensions of the exemption 1.20

The main exemption is supplemented by three subsidiary exemptions:

(1) ‘assets related to shares’ (TCGA 1992, Sch 7AC, para 2); (2) situations where the conditions for relief are not currently met, but were met within the period of two years prior to the disposal (TCGA 1992, Sch 7AC, para 3); and (3) the ordinary share capital of the investing company is owned by qualifying institutional investors (TCGA 1992, Sch 7AC, para 3A).

Assets related to shares 1.21 (i)

An asset is related to shares if it is: an option to acquire or dispose of shares;

(ii) a security that is convertible or exchangeable into shares, into an option within (i) above or into another security; (iii) an option to acquire or dispose of a security within (ii) above; (iv) an interest in, or option over, any option or security within (i)–(iii) above; or (v) an interest in, or option over, any interest or option within (iv) above. This exemption applies where Company A makes a disposal of an asset related to shares in another company, Company B, provided that Company A also 19

1.22 Corporation tax and chargeable gains owns shares in Company B and that a gain arising on a disposal of those shares at that time would be an exempt gain under TCGA 1992, Sch 7AC. This also applies where the shares are not held by Company A, but by a fellow group company provided that if the shares were held by Company A, a gain on their disposal would be an exempt gain.

Disposals where conditions met in previous two years 1.22 The second subsidiary exemption applies where the main exemption does not apply because, while the substantial shareholding requirement is satisfied at the time of the relevant disposal, either the investing or the investee company fails the relevant tests, but those tests would have been satisfied if the disposal had happened within the previous two years. This exemption applies in relation to disposals of shares, interests in shares and assets related to shares, and in effect asks the question of the test in relation to the main exemption that has been failed – could it have been passed at some point in time in the two years preceding the actual disposal? If the answer to this question is ‘yes’, then the second subsidiary exemption will apply, subject to satisfying the detailed conditions of TCGA 1992, Sch 7AC, para 3.

Exemption for investors owned by qualifying institutional investors 1.23 F(No 2)A 2017 introduced the ‘third subsidiary exemption’ which specifically applies to the sale of shares of non-trading companies (TCGA 1992, Sch 7AC, para 3A). This exemption only applies to disposals on or after 1 April 2017. The application of this new exemption to non-trading companies might appear counterintuitive, given the general focus of the SSE on trading companies. The explanation, however, is straightforward, as the Government wishes to encourage UK economic activity by various types of institutional investor, such as pension funds, insurance funds and sovereign wealth funds. These funds are exempt from UK corporation tax on any profits or gains they might make, either through a statutory exemption (for example, for pension or insurance funds) or because they are simply not UK resident taxable bodies (sovereign wealth funds, for example). However, most funds do not generally invest directly. They will, instead, set up a corporate structure to make their investments and, if they were to use a UK resident company as their investment vehicle, that would clearly be subject to UK corporation tax on its income or gains. This has meant that many such funds invest using non-UK investment vehicles, which clearly puts the UK at a 20

Corporation tax and chargeable gains 1.24 disadvantage. So the object of this exemption is that, if a suitable proportion of the investing company is held by ‘qualifying institutional investors’, any gains made by the investing company will be wholly or partly exempt. The reason that the new rule applies specifically to non-trading companies is that the main SSE would, in any case, apply to the disposal of shares of trading companies. The new exemption applies where the substantial shareholding requirement (ie 10 per cent, as described above) is met. Since this measure is aimed at institutional investors, there is an alternative rule where, even if the substantial shareholding requirement is not met, as long as the investment cost at least £20 million, a disposal can still qualify for the SSE (TCGA 1992, Sch 7AC, para 8A). If at least 80 per cent of the ordinary share capital of the investing company is owned by qualifying institutional investors (as defined in TCGA 1992, Sch 7AC, para 30A), then gains and losses when the investor company disposes of qualifying shares will be exempt in full. Where qualifying institutional investors own at least 25 per cent but less than 80 per cent of the investor company, a proportionate exemption (based on shareholding) is given.

SSE anti-avoidance 1.24 The substantial shareholding exemption does not apply where the nature of any disposal arrangements are such that the sole or main benefit of the arrangements is to secure the substantial shareholding exemption. This ‘sole or main benefit’ test is another example of a test being used in one part of the legislation and then being adapted to other uses. It first appeared in FA 1960, s 28, in the ‘transactions in securities’ legislation (now in ITA 2007, ss 682–713 and CTA 2010, ss 731–751), but is now found in, for example, the capital loss rules, referred to above, TCGA 1992, ss 137 and 139 and CTA 2010, s 1081(5), all discussed in detail later in the book. The anti-avoidance rule will only apply when the value derived from the disposal of the investee company represents untaxed profits or gains (whether realised or unrealised) if before the accrual of the gain the investing company had control of the investee company (or both have been under common control) or if there has been a significant change in the activities of the investee company whilst under the control of the investing company. This element of the anti-avoidance rule sits rather uneasily with the FA 2011 changes designed to facilitate the packaging of trading activities for sale (described above), as the new rules specifically require the investee company to begin to carry on a trade or part of a trade prior to sale. This anomaly has been pointed out to HMRC but no useful response has been published. 21

1.25 Corporation tax and chargeable gains Untaxed profits are profits that have not been brought into the charge to tax. This could include, for example, unrealised gains on capital assets or the value of goodwill. HMRC has confirmed in SP5/02 that dividends paid out of taxed profits, profits arising from an exempt disposal or where profits have been reduced by available losses are all examples of profits that will not be classed as untaxed. There are no specific examples of situations where profits will be classed as untaxed. Whilst most commercial transactions are undertaken for purposes other than to achieve an exempt disposal, some transactions are structured to take advantage of the exemption or rely on the exemption in some other way. We are not aware of HMRC applying the anti-avoidance rule since its inception, which suggests that common sense has prevailed when considering commercial transactions that innocently fall within the parameters of the anti-avoidance rules.

Scope of the exemption 1.25 The substantial shareholding exemption will be of assistance to trading groups in the general commercial environment of buying and selling trading activities (in corporate vehicles) as the requirements of the group or the focus of its trading activities change over time. The main impact will be that the ability to churn investments in trading activities will not be constrained by the system of taxation. The substantial shareholding exemption can also be used in the break-up of a group, and with the repeal of the requirements to be met by the investing company, the relief should now in theory be available where a holding company sells its only or last trading subsidiary, due to the requirement to meet the trading test immediately following the disposal having been removed. The authors are, of course, aware that HMRC appeared to permit the exemption to apply to the disposal of the last trading subsidiary of a group (and, on at least one occasion, the only trading subsidiary of a group), so long as the parent was wound up as soon as possible thereafter, on the basis of TCGA 1992, Sch 7AC, para 3(3).

Interaction with overseas taxes 1.26 One point that often arises on cross-border disposals of shares is where the application of SSE could potentially result in the taxation of the transaction at the level of the recipient. This is a good example of where different tax systems interact to create opportunities for a tax jurisdiction to allocate itself taxing rights. In recent transactions, we have come across the following examples of where the effect of SSE can be undone – in both instances, Germany was the taxing jurisdiction but it is likely that these anomalies exist in other jurisdictions. 22

Corporation tax and chargeable gains 1.26 (1) Contribution of overseas subsidiary by UK company to German company.

The German rules could deem such transaction to be a ‘hidden contribution’ which are generally taxable unless the transaction was taxed at the vendor level. The precise test is understood to be that the vendor brings fair market value consideration into account for the purposes of determining any taxes due. Under SSE, there is no adjustment to the consideration (unlike say the intragroup transfer provisions at TCGA 1992, s 171) with the resulting gain or loss exempted where SSE applies. However, the German tax authorities have been known to interpret this differently. (2) Transfer of assets by a UK branch of a German entity

Broadly, under the UK/Germany treaty, the profits of a UK branch are generally exempt provided these profits are effectively taxed in the UK, which would

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1.27 Corporation tax and chargeable gains generally be the case. However, where an asset is disposed of and any latent gains are exempt or deferred, it is possible for such assets not to meet the ‘effectively taxed’ test and be taxed at the head-office level. This point is not restricted to SSE and could equally apply to other relieving provisions, such as the intra-group transfer provisions at TCGA 1992, s 171. It is also worth noting that there is UK case law which takes a different view on the matter. In Six Continents Ltd v HMRC [2016] EWHC 2426 (Ch); [2017] STC 1228), Henderson J concluded that profits and gains falling within the Dutch participation exemption were ‘subject to tax’ in the Netherlands (and therefore profits that should be treated as attracting a tax credit). There are limitations to the application of this judgment which concluded that ‘the amount in question should be regarded as falling within the commercial profit which is in principle subject to Dutch corporation tax, although it is then eliminated’. Where no amount is subject to UK corporation by virtue of there being deemed consideration to provide for tax deferral, this is less likely to be considered commercial profit which is subject to tax in principle.

TAXATION OF INTANGIBLE FIXED ASSETS 1.27 The taxation of intangible fixed assets (IFAs) can be a complicated area of tax for a number of reasons, including the intangible nature of the assets themselves (which makes the identification of an asset more difficult) and because FA 2002 introduced a new tax regime in respect of the taxation of intangible fixed assets which now sits in CTA 2009, Pt 8 (referred to here as ‘the IFA code’).

Introduction 1.28 At a very high level, the IFA code is a specific code that relates to the taxation of IFAs and, having derived from FA 2002, this is relatively new legislation that broadly, once the relevant legal definitions that provide an entry into the code have been met, follows the accounting treatment in respect of intangibles (or hypothetical treatment if no actual amounts are recognised for accounting purposes). The boundary provision at CTA 2009, s 906 makes clear that, where an amount falls to be taxed by both CTA 2009, Part 8 and another Part of the Taxes Act, the provisions of CTA 2009, Part 8 should take precedence, subject to any indication to the contrary.

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Corporation tax and chargeable gains 1.29

Commencement 1.29 The general rule in CTA 2009, s 880 is that the IFA code in CTA 2009, Part 8 only applies to those intangible fixed assets (see 1.30) of a company that are created or acquired (from a third party) on or after 1 April 2002. The test of when an asset is created is by reference to the expenditure incurred in relation to that asset by virtue of CTA 2009, s 883. In the context of goodwill, CTA 2009, s 884 effectively sets out the test of when goodwill is deemed to have been created and broadly states that goodwill is treated as created on or after 1 April 2002 where the business was not carried out at any time before that date by the company or a related party. Where the business was carried out by the company or a related party before 1 April 2002, the associated goodwill is treated as being created before that date. This can be demonstrated by way of the following example: Example 1.1

Commenced Intra-group Transfer Third Party Acquisition Current Disposal

Business 1 Business 2 Business 3 Business 4 1992 1989 1989 2014 2015 2001 N/A N/A N/A N/A 2005 2017 2020

2020

2020

2020

In this example: ●●

Business 1 and Business 2 would be old businesses, since these commenced before 1 April 2002 and the interim transfers was intragroup (regardless of whether these were before or after 1 April 2002).

●●

Business 3 would be a new business, notwithstanding that it commenced before 1 April 2002, since it was acquired from a third party after 1 April 2002.

●●

Business 4 would be a new business, since it commenced after 1 April 2002. Any subsequent transfer is irrelevant.

For transfers of intangible assets from 1 July 2020, the commencement rules in CTA 2009, s 882 have been amended by Finance Act 2020, and the IFA regime only applies in the following circumstances: ●●

the IFA is created by the company on or after 1 April 2002; 25

1.30 Corporation tax and chargeable gains ●●

the IFA is acquired by the company between 1 April 2002 and 30 June 2020 but has been acquired from a third party; and

●●

the IFA is acquired by the company on or after 1 July 2020.

The amendment allows pre-FA 2002 assets acquired from related parties on or after 1 July 2020 to come within CTA 2009, Part 8. Where an IFA fails the commencement provisions, as in Businesses 1 and 2 above, the provisions of CTA 2009, Part 8 do not apply. These ‘old IFAs’ are dealt with under whichever tax provisions are applicable – usually, but not always, the chargeable gains provisions. There are also anti-avoidance provisions at CTA 2009, s 893 which apply where a new IFA derives its value from an old IFA which seek to ensure that the correct tax code applies in these circumstances and that old IFAs cannot be simply ‘refreshed’ into the IFA code.

Definition of an IFA 1.30 The basic definition of an ‘intangible fixed asset’ in relation to a company is contained in CTA 2009, s 713(1) as ‘an intangible asset acquired or created by the company for use on a continuing basis in the course of the company’s activities’. ‘Intangible asset’ is itself defined in CTA 2009, s 712(1) and broadly has the same meaning as it has for accounting purposes. Therefore, in order for an intangible asset to exist, it needs to be recognised for accounting purposes. This poses some difficulty when considering assets that are not recognised for accounting purposes – a common reason for that might be if the asset has been internally generated by the entity itself or another member of its group and transferred to the company at book value. The legislation contemplates this at CTA 2009, s 712(3) which states that ‘This Part applies to an intangible fixed asset whether or not it has been capitalised in the company’s accounts’. There are also references in other parts of CTA 2009, Part 8 which work around the scenario where there are no amounts actually recognised for accounting purposes, with some of these provisions discussed in further detail below. Therefore, the key test in order for there to be an IFA is that the asset would have been accounted for as an intangible asset had it been recognised for accounting purposes where an intangible asset has not been capitalised in the company’s accounts.

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Corporation tax and chargeable gains 1.31 The other requirement that is often not considered in detail is that the asset must have been acquired or created by the company for use on a continuing basis in the course of the company’s activities. As a result of this requirement, an intangible asset (whether or not capitalised in the company’s accounts) can fail to meet the definition of an IFA for the purposes of CTA 2009, Part 8 and this can give rise to anomalous results – for example, the equivalent rule to TCGA 1992, s 171 (see below) requires the asset to be an IFA in both the transferor and transferee, which might not be the case if either party does not hold the asset in the course of its activities. The term ‘chargeable intangible asset’ is defined in CTA 2009, s 741 and appears in many provisions that deal with transfers of IFAs, including the UK transfer provisions, realisations of IFAs and the related party transfer provisions (see further analysis below). A ‘chargeable intangible asset’ is an IFA in relation to which, if a gain were to arise upon its ‘realisation’, a credit is brought into account under CTA 2009, Part 8.

Realisations 1.31 A key difference between the chargeable gains regime and the IFA regime is that, under the former, the transfer of a capital asset generally gives rise to a taxable event upon the disposal (or deemed disposal) of an asset. However, under the IFA regime, it is necessary to understand whether there has been a ‘realisation’ of an IFA as defined in CTA 2009, s 734. This isn’t just a difference in terminology used. A realisation event takes place if a transaction or event results in a reduction to the accounting carrying value of an asset. Where an asset is off-balance sheet, it should be treated as though it has a balance sheet value. To determine whether there has been a realisation of an IFA, the following steps must be undertaken: ●●

determine the actual or hypothetical balance sheet value of the IFAs. This amount is not prescribed and is only necessary to answer the question of whether there has been or would have been a relative reduction in the balance sheet value;

●●

understand whether there has been a transaction or other event that gives rise to a reduction or elimination of this balance sheet value; and

●●

calculate the credit arising upon realisation. This will predominantly be based on the application of the provisions in CTA 2009, Part 8 as outlined in further detail below.

Once a realisation has been identified, it is then necessary to consider the credits and debits which should be brought into account. CTA 2009, ss 735–738 apply to determine the taxable credits where an IFA has been previously written 27

1.32 Corporation tax and chargeable gains down for tax purposes, or where the asset is shown on the balance sheet but has not been written down for tax purposes, where there is only a part-realisation or where the asset is not (or is no longer) recognised on the balance sheet. The timing of a realisation is generally aligned to the accounting treatment and it may also be possible for an event not to give rise to a realisation where, in substance, there is no derecognition of the IFA from an accounting perspective, even if the legal form of the arrangement would suggest otherwise.

Amounts to be brought into account upon realisation 1.32 The general rule is contained in CTA 2009, s 738 and effectively states that the transferor should recognise a credit equal to the proceeds of realisation (if any) under CTA 2009, Part 8. This is a factual question, as the credit to be brought into account may not always be equal to that determined for accounting purposes.

Transfers between related parties 1.33 CTA 2009, Part 8, Chapter 13 contains rules on the tax treatment of transactions between ‘related parties’. These are defined in CTA 2009, s 835 and broadly require one person to control or hold a major interest in the other person or for both persons to be under the control of the same person. ‘Control’ is itself defined in CTA 2009, s 836 as having the ability to secure that the company’s affairs are conducted in accordance with that person’s wishes by means of holding shares, possessing voting power or powers set out in the articles of association or any other document. Therefore, these related party rules are only likely to be relevant in an intra-group context. However, HMRC are known to extend the treatment to circumstances where the legal agreements do not set out a transfer between related parties but the effect of arrangements entered into by the company give rise to an in-substance transfer within the group. The transfer of IFAs was common where groups were restructuring their operations in light of Brexit. Following discussions with various industry groups and taxpayers, HMRC produced a paper that outlined the key tax considerations. In considering whether there has been a transfer of an IFA, the HMRC paper stated that it was necessary to consider what, if anything, has changed. Therefore, where the commercial reality reflects that there has been a transfer in-substance between related parties, there is likely to be a transfer of an IFA for tax purposes. Where a transfer of an IFA between related parties has been identified, the basic rule (as set out in CTA 2009, s 845(1)) is that this transfer is deemed to have been undertaken at market value where the IFA is within the charge to 28

Corporation tax and chargeable gains 1.33 UK corporation immediately before or immediately after the transfer. There are, however, some important exceptions to this rule, such as for intra-group transfers (see 1.26). For these purposes, ‘market value’ is defined in CTA 2009, s 845(2)(a) as ‘the price the asset might reasonably be expected to fetch on a sale in the open market’. This definition is consistent with what is meant by market value in the context of finance more broadly1 as well as other statutory definitions (see, for example, TCGA 1992, s 272(1)) and tax case law such as IRC v Gray [1994] STC 360, where Hoffmann LJ noted that the relevant question is ‘what would a purchaser in the open market have paid to enjoy whatever rights attached to the property at the relevant date?’. So, the same principles would appear to also apply to an IFA governed by CTA 2009, Part 8. Where the arm’s length consideration under the transfer of an IFA is imputed in accordance with the transfer pricing provisions in TIOPA 2010, Part 4, the arm’s length price would override the market value imputation as a result of the application of CTA 2009, s 846. This is regardless of whether or not a transfer pricing adjustment is made. In practice, under most circumstances, there will likely be no material differences between the open market value of an IFA and its arm’s length value. However, it is necessary to determine whether there could be any arguments that these amounts deviate. A key difference between the market value of an asset and the arm’s length principle is that the market value test appears to be based on legal principles and focuses mainly on the asset itself and what a hypothetical buyer might be willing to pay for use of that asset. In contrast, the arm’s length price appears to look at the relevant factors surrounding the relationship between the parties, rather than the asset itself, and the economic realities of the arrangement, rather than hypothesising what an unrelated party might be willing to pay. Put another way, a key difference between the arm’s length price and market value is that the former places more emphasis on the relative bargaining positions between the two parties, whilst the latter is more focused on what a hypothetical purchaser would be willing to pay in an open auction, and the same substance versus form considerations might become relevant. A difference might therefore arise where, in substance, it could be argued that there hasn’t been a realisation event at all since this is the entry condition for the intra-group transfer provisions to apply. Prima facie, the application of CTA 2009, s 846 would suggest that the consideration for a related parties transfer is to be calculated in accordance with arm’s length principles wherever there is a difference between the arm’s length price and market value. 29

1.34 Corporation tax and chargeable gains The result of this would be that, where the arm’s length price is lower than the market value of the IFA, the market value would be ignored and the corporation tax liability would be calculated based on the arm’s length price, giving rise to a lower overall UK corporation tax charge. This type of provision is not uncommon. Similar provisions also exist where there has been an appropriation of a trader’s stock, where CTA 2009, s 159 effectively imputes market value whilst CTA 2009, s 161 then gives precedence to the transfer pricing provisions. However, F(No 2)A 2015 introduced CTA 2009, s 846(1A) and (1B) which broadly provide that, where the market value of the transferred IFA exceeds the price calculated in accordance with the arm’s length principle, the difference is to be brought into account in relation to the transfer. Effectively, this means that the consideration to be used for the purposes of a transfer of an IFA between related parties is the higher of the arm’s length price and the open market value. The amendment made by F(No 2)A 2015 effectively ensures that, where the arm’s length amount could be argued to be lower, this in itself should not result in there being no regard for the actual open market value of the transaction. It also works against the taxpayer, as tax is calculated on the higher of the two amounts.

1 See, for example, the International Valuation Standards Council definition in their glossary at www.ivsc.org/ standards/glossary#letter_m.

Group transfers between UK companies 1.34 The transfer of an IFA between members of the same group, where that IFA is within the charge to UK corporation tax immediately before and after the transfer, is to be effected on a ‘tax-neutral’ basis under CTA 2009, s 775. The legislation specifically switches off the transfer pricing provisions in CTA 2009, s 775(3), and the related parties rule at CTA 2009, s 845 is also switched off by CTA 2009, s 848(1). CTA 2009, s 776 sets out what is meant by a ‘tax-neutral’ transfer for the purposes of CTA 2009, Part 8 and, broadly, the tax effect of such transfer is: ●●

there is no realisation by the transferor or acquisition by the transferee;

●●

the transferee is deemed to have held the asset at all times while it was held by the transferor; and

●●

the transferee is treated as having done all things in relation to the IFA that were done by the transferor, including retaining the tax base cost and bringing into account any credits or debits.

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Corporation tax and chargeable gains 1.35 The relief provided by CTA 2009, s 775 is therefore more akin to the ‘stand in shoes’ treatment offered by the reorganisation provisions in TCGA 1992 rather than the intra-group transfer neutrality provisions in TCGA 1992, s 171, even though the effect and purpose of these rules is largely the same. The use of a provision that provides for tax neutrality for a group transfer where an asset has not left the UK tax net is not uncommon and, given that the IFA regime bears important similarities to the capital gains regime, a rule similar to TCGA 1992, s 171 would have been expected in CTA 2009, Part 8.

Deemed realisations 1.35 Following the transfer of an IFA between members of the same group that qualifies for relief under CTA 2009, s 775, where the transferee ceases to be a member of the group within a period of six years after the date of the transfer, there is a degrouping rule at CTA 2009, s 780 which effectively reverses the tax-neutral relief provided by CTA 2009, s 775. FA 2018 introduced new CTA 2009, s 782A which provides that CTA 2009, s 780 does not apply if a company ceases to be a member of a group because of a disposal of shares by another company to which SSE applies. Where the degrouping rule applies, the transferee is treated as if it had realised the IFA and immediately reacquired it, using the market value at that time of the intra-group transfer. As a result, a credit or debit would arise and be brought into account as it would have done absent the application of CTA 2009, s 775, albeit in the transferee rather than the transferor. The degrouping rule in CTA 2009, Part 8 operates in a similar manner to the degrouping charge under the chargeable gains provisions at TCGA 1992, s 179(4) notwithstanding the subtly different means by which tax neutrality is provided under these separate regimes. It is worth noting that there is a similar rule which applies for the purposes of the loan relationships provisions in CTA 2009, Part 5 at s 345 which operates differently. Under that rule, the transferee is deemed to have assigned and reacquired the loan at market value at the point at which it ceases to be a member of the group, rather than the time at which the relationship was transferred. There could also be a deemed realisation of an IFA, under CTA 2009, s 859, where an asset ceases to be a ‘chargeable intangible asset’ in relation to a company (see definition at 1.30 above).

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1.36 Corporation tax and chargeable gains The circumstances in which there could be a deemed realisation under CTA 2009, s 859 are: ●●

the migration of a UK tax resident company;

●●

any circumstance that does not involve a realisation of the IFA by a non-UK tax resident company. Broadly, this is where an asset ceases to be used for the purposes of a UK permanent establishment of a non-UK tax resident company and is no longer attributed as such; and

●●

the IFA becoming held for the purposes of a mutual trade or business.

There are postponement provisions for bringing into account the gain arising upon migration but not any of the other circumstances listed above.

TAXATION OF LOAN RELATIONSHIPS 1.36 This section sets out a broad introduction to the loan relationship provisions and is intended to contextualise the comments made in the ensuing chapters relating to loan relationships. This section only covers general comments on how the loan relationships provisions apply and specific rules relating to loans and transfers between related parties to demonstrate any similarities in the provisions relating to chargeable gains in this chapter (for example, relief under TCGA 1992, s 171).

Overview of the loan relationship provisions 1.37 Broadly, the loan relationships regime in CTA 2009, Part 5 sets out a comprehensive set of provisions which apply to the taxation of a company’s ‘loan relationships’. CTA 2009, Part 6 sets out matters that are treated as if they are loan relationships in respect of certain specified amounts. The matters dealt with by CTA 2009, Part 6 include relevant non-lending relationships, disguised interest, transferred income streams, manufactured interest and repos. We have not considered the application of CTA 2009, Part 6 in this book since that would go beyond a mere introduction to the loan relationships regime, but it is important to bear in mind that the provisions in CTA 2009, Part 6 can extend the scope of the loan relationships regime to matters that do not strictly meet the definition of a ‘loan relationship’. This regime is commonly seen as a ‘follow the accounts’ type regime and, whilst that could be correct in most circumstances, in the author’s view,

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Corporation tax and chargeable gains 1.38 CTA 2009, Part 5 sets out the following methodical approach that needs to be followed: (1)

Establish whether a loan relationship exists. The test here is certainly not based on accounting principles and relies on a statutory definition for tax purposes and principles established by the UK courts.

(2) Once a loan relationship has been identified, it is necessary to identify which matters relating to that loan relationship are to be brought into account. Again, these matters are defined in tax statute with limited regard for the accounting treatment. (3) Once the relevant matters have been identified, it is necessary to determine the credits and debits that must be brought into account for the purposes of UK corporation tax. This step is where the accounting treatment becomes relevant. (4) Even if amounts exist (or do not exist) for accounting purposes, it is then necessary to consider the extent to which any specific statutory provisions (whether through primary or secondary legislation) could qualify the amounts that would otherwise be brought into, or left out of, account under Step 3. (5) The last step is to consider how the credits and debits that are to be brought into account under the loan relationships regime are to be presented in the tax return of the company. An important point to note is that the method outlined above is only in respect of the application of CTA 2009, Part 5 to loan relationships. There could be other provisions within the Taxes Acts which qualify the amounts that are ultimately brought into account for the purposes of UK corporation tax that could apply following Step 5 above. For example, the hybrid and other mismatches provisions (in TIOPA 2010, Part 6A) or corporate interest restriction provisions (in TIOPA 2010, Part 10) could further qualify the amounts that are ultimately presented in a company’s tax return. The remainder of this section sets out this five-step approach in further detail.

What is a ‘loan relationship’? 1.38

Broadly, a ‘loan relationship’ is defined in CTA 2009, s 302 as:

●●

the company stands in the position of a creditor or debtor as respects any ‘money debt’; and

●●

that debt arises from a ‘transaction for the lending of money’. 33

1.39 Corporation tax and chargeable gains A ‘money debt’ is defined in CTA 2009, s 303(1) as a debt which falls to be settled by the payment of money, by the transfer of a right to settlement under a debt which is itself a money debt, or by the issue or transfer of shares. The term ‘transaction for the lending of money’ is not defined in statute and so its interpretation should be based on general principles. This leaves the phrase to be construed in accordance with its ordinary meaning and there are several cases which have considered the question of what amounts to a transaction for the lending of money. Case law1 in this area suggests that a transaction for the lending of money means an advance of a principal sum due on maturity where one party is borrower and another is lender. It is worth noting that the term ‘transaction for the lending of money’ is extended to include situations where an instrument is issued for the purposes of representing security for, or the rights of a creditor in respect of, a money debt by virtue of CTA 2009, s 303(3). The usual examples used to demonstrate whether or not a loan relationship exists are a bank loan versus a trade creditor. The clear difference here is that, for the latter, there isn’t the advance of a principal sum due or an instrument that is issued, so there is no transaction for the lending of money and, as such, no loan relationship. A bond is likely to meet the definition of a loan relationship, even though the lender would not have advanced a principal sum to the holder, on the basis that this is an instrument that has been issued and is currently an asset of the holder.

1 HSBC Life v Stubbs (Inspector of Taxes) [2002] STC 9 at paras 57 and 58, and MJP Media Services Limited v The Commissioners for HMRC [2010] UKFTT 298 (TC) at para 89.

Relevant matters 1.39 The legislation clearly sets out the matters in relation to a loan relationship that must be brought into account. These are: ●●

all profits and losses arising from a company’s loan relationships and ‘related transactions’ (including reference to exchange gains and losses) (under CTA 2009, s 306A(1)(a));

●●

all interest under a company’s loan relationships and all expenses incurred under or for the purposes of those relationships and transactions (under CTA 2009, s 306A(1)(b), (c)); and

●●

amounts in respect of a loan relationship that are accounted for as capital expenditure with no profit or loss (excluding IFAs, writing down the asset, amortisation or depreciation) (under CTA 2009, s 320). 34

Corporation tax and chargeable gains 1.40 For these purposes, a ‘related transaction’ is defined as any disposal or acquisition (in whole or in part) of rights or liabilities under the relationship in CTA 2009, s 304. The key implications of a matter being within the loan relationships code are that (i) this regime provides for exclusivity as a result of CTA 2009, s 464 (ie this code takes precedence where an amount falls within more than one part of the UK tax provisions, subject to any express provision to the contrary), and (ii) all profits and losses arising to a company from its loan relationships are treated as amounts of income (rather than capital) as a result of CTA 2009, s 295.

Credits and debits to be brought into account 1.40 CTA 2009, s 308 effectively states that the amounts recognised in determining a company’s profit or loss are to be brought into account for the purposes of UK corporation tax. This is the first hint of the ‘follow the accounts’ approach and effectively states that the starting position when considering the tax treatment is the P&L account (or income statement) of the company. F(No 2)A 2015 removed the requirement in old CTA 2009, s 307 that credits and debits brought into account must ‘fairly represent’ profits and gains arising from loan relationships. This was a subjective test that either taxpayers or HMRC would use to their advantage, depending on the context in question. This caused much confusion and often contradictory case law. F(No 2)A 2015 did, however, introduce a regime TAAR, which applies to the loan relationship regime as a whole (see CTA 2009, s 455B et seq) and considers the extent to which a tax advantage could be considered contrary to the principles and policy objectives of the loan relationships legislation. The intention of this TAAR was to apply a more consistent approach when considering whether the credits and debits brought into account conform to the intentions of Parliament when enacting these rules. Amounts recognised as items of other comprehensive income (OCI) are no longer brought into account for accounting periods beginning on or after 1 January 2016, except where: ●●

amounts brought into account were previously recognised in OCI and are subsequently transferred to profit or loss (CTA 2009, s 308(1A)); or

●●

amounts recognised in OCI, and not transferred to profit or loss when a loan relationship, or part of a loan relationship, ceases to be recognised in a company’s accounts, are no longer expected to be transferred to profit and loss (CTA 2009, s 320A).

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1.41 Corporation tax and chargeable gains

Tax qualifications 1.41 If the loan relationships code was merely a ‘follow the accounts’ regime, the legislation would have ended at CTA 2009, s 308 and CTA 2009, Part 5 would have been very short. However, CTA 2009, ss 320–475 may apply to alter the assumptions made in bringing into account debits and credits under GAAP (ie tax may not follow the accounts) for loan relationships. Some of these adjustments are discussed in further detail below.

Presentation 1.42 If, for an accounting period, the company is party to the loan relationship for the purposes of a trade it carries on, any credits and debits in respect of such relationship should be brought into account under CTA 2009, Part 3 as a trading amount as a result of CTA 2009, s 297, and any losses are dealt with under the trading loss provisions. For all other loan relationships, these are brought into account under CTA 2009, s 299 as a non-trading loan relationship amount under CTA 2009, Part 5, and any deficits are dealt with under the non-trading deficit provisions.

Connected companies relationships 1.43 An example of where the loan relationships qualify amounts that are brought into account in accordance with the accounting treatment is in respect of ‘connected companies relationships’. These are defined in CTA 2009, s 348 as a loan relationship between two companies which are ‘connected’. Two companies are ‘connected’ for these purposes if the tests in CTA 2009, s 466 are met for an accounting period. Broadly, this is where one entity controls the other, or both entities are held under common control. One of the key implications of having a connected companies relationship is that the amortised cost basis of accounting is deemed to apply, regardless of the actual accounting treatment, as a result of CTA 2009, s 349. Therefore, even where the debtor company or the creditor company accounts for the loan relationship using the fair value method of accounting, the amortised cost basis must be adopted for the purposes of UK corporation tax. In practice, loans between connected parties would be expected to be accounted for using the amortised cost basis of accounting in any case, so there is unlikely to be any tax-specific adjustments in these circumstances. The definition of ‘amortised cost’ has been amended by F(No 2)A 2015 to align with the corresponding accounting definition. As a result, the definition of ‘amortised cost’ in CTA 2009, s 313 now includes reference to the 36

Corporation tax and chargeable gains 1.45 effective interest method rather than adjustments for cumulative amortisation, impairment, repayment and release. The other key implications of having a connected companies relationship is that any debits arising upon impairment or release of debt are not deductible as a result of CTA 2009, s 354(1), and any credits arising to the debtor upon release are not taxable as a result of CTA 2009, s 358(1). This is subject to the so-called ‘deemed release provisions’ which are discussed in further detail below. Any reversals of impairments and releases are similarly ignored for the purposes of UK corporation tax. CTA 2009, s 358(2) sets out the exceptions to the general rule that any credits arising to the debtor upon release are not taxable, and these are limited to (i) deemed releases under either CTA 2009, s 361 or 362 or (ii) where there has been a release of ‘relevant rights’. These have not been considered in this book but are complex areas of the tax code that usually require further analysis.

Transfers of loan relationships within groups 1.44 The loan relationship provisions also provide for continuity of treatment where a loan relationship is transferred within a group and both the transferor and transferee are within the charge to UK corporation tax. CTA 2009, Part 5, Chapter 4 sets out the key operative provisions and, whilst this section only considers continuity in the context of transfers within groups, Chapter 4 also deals with transfers of loans on insurance business transfers and the issue of new securities on certain cross-border reorganisations. For these purposes, CTA 2009, s 335(6) sets out the relevant definition of a group: ‘(6) In this Chapter references to a company being a member of a group of companies are to be read in accordance with section 170 of TCGA 1992 (interpretation of sections 171 to 181 of that Act: groups).’ Therefore, the same grouping rules that were discussed in the context of a TCGA 1992, s 171 transfer would be relevant for the transfer of loan relationships.

CTA 2009, s 336(1)–(3) 1.45 ‘(1) The case referred to in section 335(1)(a) is where– (a) there is a transaction within subsection (2) or a series of transactions within subsection (3), and 37

1.46 Corporation tax and chargeable gains (b) as a result one of the companies involved (“the transferee”) directly or indirectly replaces the other (“the transferor”) as a party to a loan relationship. (2) A transaction is within this subsection if it is a related transaction between two companies which are– (a) members of the same group, and (b) within the charge to corporation tax in respect of that transaction. (3) A series of transactions is within this subsection if it is a series having the same effect as a related transaction between two companies each of which– (a) has been a member of the same group at any time in the course of that series, and (b) would be within the charge to corporation tax in respect of such a related transaction.’ There are further provisions relating to assets held for the purposes of a company’s long-term business and overseas life insurance companies, which are outside the scope of this book.

Analysis 1.46 This provision is similar to the chargeable gains equivalent in TCGA 1992, s 171 in that it requires a related transaction between two members of the same group which are both within the charge to UK corporation tax. A key difference between these provisions is that CTA 2009, s 336 contains the concept of a series of transactions which effectively allows for the interposition of intermediate companies which are part of the same arrangement and the ultimate transferor and transferee meet the tests in CTA 2009, s 336(2). The aim of this rule is to ensure that the continuity of tax treatment is not impacted by any intervening steps. For example, under old UK GAAP, it was possible to have debts with latent losses or gains that were not triggered until transfer and the group continuity rules would prevent the crystallisation of these gains or losses between UK parties. In the absence of a series of transactions rule, the interposition of a non-UK group entity could result in gains or losses being crystallised where they would otherwise not be. An implication of a series of transactions being within the ambit of CTA 2009, s 336 is that a loan could leave the UK group and re-enter the UK group on 38

Corporation tax and chargeable gains 1.46 a tax-neutral basis but the intervening steps could result in tax implications elsewhere. Once it has been established that CTA 2009, s 336 applies, CTA 2009, s 340 sets out that the transfer is at the tax-adjusted carrying value which is defined in CTA 2009, s 465B as the accounting carrying value of the loan relationship as adjusted by various tax provisions that are specified in CTA 2009, s 465B(9). These provisions do not apply if the transferor company uses fair value accounting as a result of CTA 2009, s 341. An interest point is that the provisions do not specify how CTA 2009, s 340 operates where the transferee uses fair value accounting. Implicitly, it is the view of the author that the loan relationship is deemed to transfer at its tax-adjusted carrying value and then immediately recognised at fair market value in the hands of the transferee. This would be appear to be consistent with the principles of the loan relationship provisions. CTA 2009, s 344(1) requires that CTA 2009, ss 345 and 346 need to be considered where a transfer meets the requirements of CTA 2009, s 336 and ‘before the end of the relevant 6 year period and while still a party to the relevant loan relationship, the transferee ceases to be a member of the relevant group’. CTA 2009, s 345 tells us that, if the transferee leaves the group within 6 years, otherwise than because of an exempt distribution, there is a deemed disposal and reacquisition by the transferee company at fair value immediately before the transferee company leaves the group. The mechanism for the clawback is a deemed disposal of the loan relationship asset and reacquisition at fair market value immediately before the time the transferee company left the group. This mechanism is subtly different from the degrouping charge for chargeable assets (TCGA 1992, s 179), which uses a deemed disposal and reacquisition at market value at the time of the relevant intra-group disposal, rather than using the value at the date of the degrouping event. This can be demonstrated by the following example. Example 1.2 Miller Ltd made a Loan to Debtor Co of £10m on 30 August 2014 and transferred it to a newly incorporated UK resident subsidiary, Hardy Ltd, on 16 June 2015 for its fair market value of £12m in return for share consideration. On 5 May 2017, the Loan had a fair market value of £15m and Miller Ltd sold its shares in Hardy Ltd to Ismail Ltd, a third party, for cash consideration of £15m. Each of these entities has a calendar year end. 39

1.47 Corporation tax and chargeable gains Analysis: The transfer of the Loan should fall within CTA 2009, s 340 and is therefore deemed to take place at the tax-adjusted carrying value of £10m, regardless of the actual consideration paid. The sale of the shares in Hardy Ltd should trigger the degrouping charge in CTA 2009, s 345, so Hardy Ltd is deemed to have disposed of the Loan at its fair market value of £15m at the time that the company was sold by Miller Ltd, and to have subsequently reacquired the Loan for the same amount. The effect of CTA 2009, s 345 is that a loan relationship credit of £6m is deemed to arise in Hardy Ltd in the accounting period ending 31 December 2017. From a chargeable gains perspective, Miller Ltd had a base cost in Hardy Ltd of £12m, being the fair market value of the shares received under TCGA 1992, s 17. At the time of disposal, Miller Ltd received £15m from Ismail Ltd such that a chargeable gain of £3m arises in Miller Ltd. The rules in TCGA 1992, s 37 only reduce the amount of the consideration for amounts brought into account in computing income or profits of the person making the disposal, which is not the case here. And there is no equivalent in the loan relationships rules to the provisions that prevent double taxation for capital gains purposes. This could therefore give rise to potential double taxation for the same economic gain. The only fall back appears to be case law in respect of double taxation, for example HMRC v Investec [2018] UKUT 413, although reliance on principles established by case law is always less helpful than an express statutory provision, as it is necessary to consider points of similarity and distinction. There are also provisions relating to the transferee leaving a group as a result of an exempt distribution (see Chapter 24).

TAXATION OF DERIVATIVE CONTRACTS 1.47 This section sets out a broad introduction to the derivative contract provisions and is intended to contextualise the comments made in the ensuing chapters relating to derivative contracts. This section only covers general comments on how the derivative contracts provisions apply and specific rules relating to transfers between related parties to demonstrate any similarities in the provisions relating to chargeable gains in this chapter (for example, relief under TCGA 1992, s 171).

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Corporation tax and chargeable gains 1.49

Overview of the derivative contract provisions 1.48 Broadly, the derivative contracts regime in CTA 2009, Part 7 was introduced by FA 1996 at the same time as the loan relationship provisions and, for the most part, bears some important similarities to the loan relationships regime. In particular, the derivative contracts regime is also commonly seen as a ‘follow the accounts’ type regime and, like the loan relationships regime, in the author’s view, CTA 2009, Part 7 sets out the same methodical approach: (1) Establish whether a derivative contract exists. The test here is certainly not based on accounting principles and relies on a statutory definition for tax purposes and principles established by the UK courts. (2) Once a derivative contract has been identified, it is necessary to identify which matters relating to that derivative contract are to be brought into account. Again, these matters are defined in tax statute with limited regard for the accounting treatment. (3) Once the relevant matters have been identified, it is necessary to determine the credits and debits that must be brought into account for the purposes of UK corporation tax. This step is where the accounting treatment becomes relevant. (4) Even if amounts exist (or do not exist) for accounting purposes, it is then necessary to consider the extent to which any specific statutory provisions (whether through primary or secondary legislation) could qualify the amounts that would otherwise be brought into, or left out of, account under Step 3. (5) The last step is to consider how the credits and debits that are to be brought into account under the derivative contracts regime are to be presented in the tax return of the company. Like the loan relationships regime, the method outlined above is only in respect of the application of CTA 2009, Part 7 to derivative contracts. There could be other provisions within the Taxes Acts which qualify the amounts that are ultimately brought into account for the purposes of UK corporation tax that could apply following Step 5 above.

What is a ‘derivative contract’? 1.49 Broadly, a ‘derivative contract’ is defined in CTA 2009, s 576 as a contract that: ●●

is a relevant contract (which is itself defined in CTA 2009, s 577 as an option, future or contract for differences);

41

1.50 Corporation tax and chargeable gains ●●

meets the accounting conditions in CTA 2009, s 579 which broadly require that the contract is treated for accounting purposes as a derivative, but alternatively certain other tests could also be met relating to the underlying subject matter of the contract; and

●●

is not excluded under CTA 2009, s 589 – broadly, this requires the underlying subject matter to be an IFA, certain shares or certain rights of a unit holder under a unit trust scheme.

The definition of a derivative contract is more prescriptive than a loan relationship and there are various definitions that become relevant, depending on the nature of the underlying contract. For example, CTA 2009, s 580 defines an ‘option’ and CTA 2009, s 581 defines a ‘future’. In practice, it is necessary to review the terms of each contract to understand whether it has the necessary hallmarks to be considered an option or future and consider whether the tax definitions have been met. In most instances, there is usually alignment between the tax and general finance definitions of an option or future. In practice, a ‘contract for difference’ (which is defined in CTA 2009, s 582) is more subjective and usually requires further consideration. Broadly, this definition requires that the contract has the purpose or ‘pretended purpose’ to make a profit or avoid a loss by reference to fluctuations in the value or price of property described in the contract or an index or other factor designated in the contract. CTA 2009, s 582(2) also sets out an exhaustive list of matters that are not a contract for difference as an option, future, contract of insurance, capital redemption policy, contract of indemnity, guarantee, warranty or loan relationship. Again, in practice it is necessary to review the terms of the contract to understand whether a contract for differences exists.

Relevant matters 1.50 The legislation clearly sets out the matters in relation to a derivative contract that must be brought into account. These are: ●●

all profits and losses arising from a company’s derivative contracts and ‘related transactions’ (under CTA 2009, s 594A(1)(a));

●●

all expenses incurred under or for the purposes of those contracts and transactions (under CTA 2009, s 594A(1)(b)); and

●●

amounts in respect of a derivative contract that are accounted for as capital expenditure with no profit or loss (excluding IFAs, writing down the asset, amortisation or depreciation) (under CTA 2009, s 604).

42

Corporation tax and chargeable gains 1.51 For these purposes, a ‘related transaction’ is defined as any disposal or acquisition (in whole or in part) of rights or liabilities under the contract in CTA 2009, s 596. The key implications of a matter being within the derivative contracts code are that (i) this regime provides for exclusivity as a result of CTA 2009, s 699 (ie this code takes precedence where an amount falls within more than one part of the UK tax provisions, subject to any express provision to the contrary), and (ii) all profits and losses arising to a company from its derivative contracts are treated as amounts of income (rather than capital) as a result of CTA 2009, s 571.

Credits and debits to be brought into account 1.51 CTA 2009, s 595 effectively states that the amounts recognised in determining a company’s profit or loss are to be brought into account for the purposes of UK corporation tax. This is the first hint of the ‘follow the accounts’ approach and effectively states that the starting position when considering the tax treatment is the P&L account (or income statement) of the company. F(No 2)A 2015 removed the requirement in old CTA 2009, s 595 that credits and debits brought into account must ‘fairly represent’ profits and gains arising from derivative contracts. This was a subjective test that either taxpayers or HMRC would use to their advantage, depending on the context in question. This caused much confusion and often contradictory case law. F(No 2)A 2015 did, however, introduce a regime TAAR, which applies to the derivative contracts regime as a whole (see CTA 2009, s 698B et seq) and considers the extent to which a tax advantage could be considered contrary to the principles and policy objectives of the derivative contracts legislation. The intention of this TAAR was to apply a more consistent approach when considering whether the credits and debits brought into account conform to the intentions of Parliament when enacting these rules. Amounts recognised as items of other comprehensive income (OCI) are no longer brought into account for accounting periods beginning on or after 1 January 2016, except where: ●●

amounts brought into account were previously recognised in OCI and are subsequently transferred to profit or loss (CTA 2009, s 597(1A)); or

●●

amounts recognised in OCI, and not transferred to profit or loss when a loan relationship, or part of a loan relationship, ceases to be recognised in a company’s accounts, are no longer expected to be transferred to profit and loss (CTA 2009, s 604A). 43

1.52 Corporation tax and chargeable gains

Tax qualifications 1.52 If the derivative contracts code was merely a ‘follow the accounts’ regime, the legislation would have ended at CTA 2009, s 595 and CTA 2009, Part 7 would have been very short. However, CTA 2009, ss 597–710 may apply to alter the assumptions made in bringing into account debits and credits under GAAP (ie tax may not follow the accounts) for derivative contracts. Some of these adjustments are discussed in further detail below.

Presentation 1.53 If, for an accounting period, the company is party to the derivative contract for the purposes of a trade it carries on, any credits and debits in respect of such relationship should be brought into account under CTA 2009, Part 3 as a trading amount as a result of CTA 2009, s 573, and any losses are dealt with under the trading loss provisions. For all other loan relationships, these are brought into account under CTA 2009, s 574 as a non-trading loan relationship amount under CTA 2009, Part 5, and any deficits are dealt with under the non-trading deficit provisions.

Transfers of derivative contracts within groups 1.54 The derivative contracts provisions provide for continuity of treatment where a derivative contract is transferred within a group and both the transferor and transferee are within the charge to UK corporation tax. These provisions are set out in CTA 2009, Part 5, Chapter 5 and are almost identical to the provisions relating to loan relationships. For example, the main operative provision at CTA 2009, s 625(3) sets out that the transfer is at the tax-adjusted carrying value which is defined in CTA 2009, s 702 as the accounting carrying value of the derivative contract as adjusted by various tax provisions that are specified in CTA 2009, s 702(8). There are also similar degrouping rules at CTA 2009, ss 631 and 632 which apply in an almost identical manner to the loan relationship provisions. In practice, derivative contracts are generally always accounted for at fair market value and, unlike the loan relationship provisions, there is no statutory deeming provision in CTA 2009, Part 7 which requires a derivative contract between connected persons to be deemed to be accounted for on an amortised cost basis. Therefore, the effect of any group continuity rule is likely to be limited. In any case, CTA 2009, s 628 applies where the transferor applies fair value 44

Corporation tax and chargeable gains 1.55 accounting and disapplies the group-continuity rule in these circumstances. Instead, CTA 2009, s 628(2) deems the transfer to take place at fair market value as at the date of transfer. Prior to the implementation of FRS 102, it was more common under old UK GAAP for derivative contracts to be accounted for on an amortised cost basis which resulted in anomalies, but this has become far less common of late.

Capital allowances 1.55 Capital allowances claims underpin the corporation tax computation by giving tax relief for capital expenditure on qualifying assets. Various types of capital allowance exist for different assets or uses, but the most commonly claimed type is plant and machinery allowances. Most of the relevant legislation is set out in Capital Allowances Act 2001 (‘CAA 2001’), Part 2. There are two key capital allowances issues to consider during a reconstruction: ●●

which entity (if any) is able to claim, or continue to claim, capital allowances; and

●●

the requirement to account for disposal proceeds (also called a ‘disposal value’) in the capital allowances computation. This is a potential statutory requirement to subtract qualifying expenditure in the capital allowances computation (in effect, negative capital allowances) to reflect what the qualifying assets are worth, or are deemed to be worth, at the time of the disposal. Accounting for disposal proceeds for capital allowances purposes can reduce current or future tax relief or create a balancing charge (commonly referred to as a ‘claw-back’) which increases taxable profits, giving rise to an additional tax liability.

Under basic principles, a company is entitled to claim plant and machinery allowances if it meets the general conditions of CAA 2001, s 11. This requires the company to have incurred qualifying expenditure on plant or machinery wholly or partly for the purposes of a qualifying activity (that is, a business activity listed in CAA 2001, s 15) carried on by it, and the company must own the plant or machinery as a result of incurring the expenditure. For plant and machinery fixtures, CAA 2001, Part 2, Chapter 14 (‘Fixtures’) also sets out additional rules that can deem a taxpayer to own fixtures for capital allowances purposes, even if it does not own those fixtures under real estate law. A disposal value is required to brought into account for plant or machinery if a disposal event occurs, as listed in CAA 2001, s 61 – for example, the company ceases to own the plant or machinery, or it begins to be used wholly or partly for purposes other than the qualifying activity, or the qualifying activity is permanently discontinued. 45

1.56 Corporation tax and chargeable gains The legislation also specifies how the disposal value should be calculated. As a basic principle, this is simply the amount received for the qualifying assets (or, under CAA 2001, s 562, a fair and reasonable apportionment of those proceeds received), which, according to CAA 2001, s 62, cannot exceed the qualifying expenditure pooled. But, depending on the particular circumstances, another amount may have to be used, such as market value or an apportionment of it. Expenditure on plant and machinery is generally pooled (that is, recorded in the tax computation with expenditure from other properties that have similar characteristics for tax purposes), and bringing in a disposal value reduces the value of the pool. This means that the capital allowances are partly or fully clawed back, with the company not only losing the ability to claim future tax relief for qualifying expenditure not yet written off for tax, but also having tax relief given previously clawed back, because of lower tax relief on the reduced pool balance after having subtracted the disposal value. If the disposal value exceeds the pool balance, this results in a balancing charge (in effect, a requirement to declare additional taxable income in the period of disposal), although this is uncommon for a continuing business because it is more usual for the disposal proceeds to simply reduce the pool balance that is available to use and carried forward. However, in the final chargeable period, depending on whether the pool balance (called ‘available qualifying expenditure’) exceeds the disposal value (referred to as the ‘total of any disposal receipts’), either a balancing allowance or a balancing charge could arise. A balancing allowance is a mechanism by which any unused tax relief arising from capital allowances is made available to use in the final period, and it arises where the pool balance is greater than the disposal value. Conversely, a balancing charge arises where the pool balance is less than the disposal value and is the method by which tax relief is clawed back by imposing a one-off tax liability in the final period. Fortunately, the tax legislation does provide mechanisms to avoiding adverse capital allowances implications during reconstructions, where specified conditions are met.

TAX AVOIDANCE AND ANTI-AVOIDANCE 1.56 There has been tax avoidance ever since there have been taxes and this is certainly true of the UK and its tax system. As a result, there have also been various kinds of anti-avoidance activities by the taxing authorities. For the purposes of this introduction, we will look at the statutory ways of preventing tax avoidance and at the non-statutory jurisprudence, the so-called ‘Ramsay doctrine’1. First, however, perhaps we should come up with a working definition of ‘avoidance’ for these purposes. This is a matter that many people have 46

Corporation tax and chargeable gains 1.56 considered in the past and no one definition has ever achieved universal approval. No doubt, in part, this is because what taxpayers and practitioners view as being acceptable use of the rules, the taxing authorities might see as an abuse of the legislative intention. Nevertheless, a fair starting point could be that avoidance occurs when a transaction is structured specifically in a way that reduces the amount of tax that would be payable in accordance with the intention of Parliament had the transaction not been structured in that fashion. Of course, this begs the question as to what is the intention of Parliament. Anyone who has observed or read a Finance Bill debate will be aware that the average MP has not been trained to understand the technical details of the tax system. On the other hand, most of them will understand the broad intention of a piece of legislation. For example, most MPs will have understood that the substantial shareholding exemption was designed to exempt disposals of subsidiaries by trading groups from taxation. So they would understand that planning to bring an investment activity within the exemption might be ‘tax avoidance’. However, they are unlikely to know enough about the detail of the legislation to be able to have any real ‘intention’ as to how, for example, the detailed provisions defining a joint venture were intended to work. As we shall see, the Ramsay doctrine has now been interpreted as requiring an understanding of the purpose of the relevant piece of legislation, as it can be understood from the detailed words of the legislation. This intention might be understood as part of a coherent system of taxation, although with some of the more ‘closely articulated’ legislation of more recent Finance Acts, such a contextual approach may not be available to the courts. In light of the level of scrutiny actually given by MPs, this approach might be seen as a sensible alternative to understanding ‘intention’ in the sense of the thoughts of the legislators. We can at least say that we can discern the intention of the tax policy-makers by inspecting the detailed words of the legislation. And perhaps we have to assume that those policy-makers act as a proxy for Parliament in this time of hugely complex tax legislation. However, the concern in more recent times is that this approach has effectively allowed HMRC to usurp the role of the legislature and to give itself excessive powers and pass draconian tax rules to counter what it perceives as abuses, without proper regard for the democratic process. It was once hoped that this trend might be checked by the introduction of a general anti-avoidance rule (‘GAAR’) in Finance Act 2013 (see below). However, the authors see no evidence of any reduction in the quantity and breadth of anti-avoidance legislation in the six years since then.

1 After WT Ramsay Ltd v IRC 54 TC 101.

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1.57 Corporation tax and chargeable gains

Statutory anti-avoidance rules – a brief history 1.57 A simplistic view of the history of tax avoidance from the perspective of HMRC might begin with a story of how taxpayers (or their advisers) would find a loophole in the legislation and exploit it, then the Revenue would find out about the loophole and plug it, then taxpayers would find another loophole, and so on. This simple story is not without an element of naïve truth. The Taxes Acts are littered with anti-avoidance provisions that have arisen in this way, and whenever HMRC has to field complaints about the complexity of the tax code, a favourite defence is to blame it on the continued need to protect tax revenues from the ingenuity of the tax avoiders. Indeed, during the late 1950s and into the 1960s, a combination of high tax rates and decreasing popular support for such a tax system led to tax avoidance becoming an industry in itself and spawned a series of generic avoidance schemes that often had no relation to the business activities of the users; they were just off-the-shelf avoidance schemes with no commercial content at all. The Revenue attacked these forms of avoidance in two ways. First, instead of precisely targeted anti-avoidance provisions, a series of much more widelyworded provisions were enacted intended to have broad application so that various generic types of planning could be closed down. Examples of this approach include the transactions in securities legislation (at ITA 2007, ss 682–713 and CTA 2010, ss 731–751), the transfers of assets abroad legislation (ITA 2007, s 714 et seq) and the transactions in land legislation (ITA 2007, s 752 et seq and CTA 2010, s 815 et seq). The deliberately wide scope of such legislation was clear from the 1960 Budget resolution when what are now CTA 2010, s 731 et seq and ITA 2007, s 682 et seq were enacted as FA 1960, s 28. The resolution stated that this legislation was ‘a general anti-avoidance provision which will be applicable in a limited field where avoidance is persistent and blatant’. It was accepted that the powers granted to the Revenue were wide, but this was the only way ‘to stop the spread of devices which are at present being exploited and to stop future devices in this field from being born’. In the Budget proposals debate, the then Chancellor of the Exchequer, Derrick Heathcote-Amory, said that the measures were particularly aimed at dividend stripping and bond washing (Hansard, 7 April 1960, vol 621, col 691), although they clearly cover a far wider range of transactions than just these. Indeed, the Budget resolution stated that the new rule would ‘have the further advantage that it will give the Revenue protection against devices (outside the immediate dividend stripping and bond washing fields) which might be adopted in connection with stocks, shares and securities’. This approach was reinforced by the willingness of the courts to interpret such legislation as widely as possible in order to give effect to the stated legislative intention to eliminate avoidance in these areas. Not only was a wide 48

Corporation tax and chargeable gains 1.58 interpretation implicit within the statute itself (see, for example, the wide scope of the definitions in CTA 2010, s 731 et seq and ITA 2007, s 682 et seq), but, as Lord Reid said in the case of IRC v Greenberg 47 TC 240, a case concerned with this legislation: ‘… I must recognise that plain words are seldom adequate to anticipate and forestall the multiplicity of ingenious schemes which are constantly being devised to evade taxation. Parliament is very properly determined to prevent this kind of tax evasion and if the courts find it impossible to give very wide meanings to general phrases, the only alternative may be for Parliament to do as some other countries have done and introduce legislation of a more sweeping character, which will put the ordinary well-intentioned person at much greater risk than is created by a wide interpretation of such provisions as those which we are now considering.’ The other approach was to attack both the users and promoters of these schemes. In the 1960s, a large number of schemes were promoted by the Rossminster banking group1, several of which became immortalised in wellknown cases, including the Ramsay case itself. The old Revenue approach would have involved changing the law where appropriate and testing the planning by litigating a test case. However, once the extent of the development of the tax planning industry became apparent, the Revenue made it clear that it would litigate every case possible, either on technical grounds or on the basis of faulty implementation. Furthermore, the Revenue also attacked the promoters personally, accusing them of tax fraud. In the event, this approach caused the individuals a great deal of personal inconvenience and stress (for example, their homes were raided under the powers the Revenue then had), but the Revenue was unable to find any evidence of fraud by the promoters of these schemes.

1 These were the subject of The Tax Raiders and The History of Tax Avoidance by Nigel Tutt.

Statutory anti-avoidance rules – where are we now? 1.58 Despite the best efforts of the Inland Revenue and later HMRC, there are still people designing and selling tax avoidance schemes, albeit to a lesser extent. While, at first, the Revenue took a piecemeal approach to closing these down, other approaches have gradually been developed. First, most new legislation over the past 15 or 20 years has embedded targeted anti-avoidance provisions (often called ‘TAARs’). So, for example, the substantial shareholding exemption has paragraph 5 which precludes the operation of the exemption where the sole or main purpose of arrangements is to get within it. 49

1.59 Corporation tax and chargeable gains Secondly, HMRC is making greater use of the motive test in legislation. As we saw above, the FA 2006 rules incorporate a ‘sole or main purpose’ test, so that relief for capital losses is denied when the taxpayer’s motivation is tax avoidance. These tests are occasionally, but not always, accompanied by a pretransaction clearance facility. More recently, legislation also includes a ‘principles and policy objectives’ test, whereby regard is to be had to purposive interpretation of the relevant legislation. Examples of this can be seen in the loan relationships TAAR in CTA 2009, s 455C and the hybrid and other mismatches provisions TAAR safe harbour at TIOPA 2010, s 259M. Thirdly, much of the new anti-avoidance legislation is deliberately far reaching and widely drawn (following the lead of the transactions in securities rules from FA 1960). Taking the FA 2006 capital loss rules again, the rules to prevent the use of capital losses against income profits were deliberately drawn up to provide ‘protection against future schemes which aim to use capital losses to reduce income profits’1. So the provision is drawn up to pre-empt future schemes, as well as to close down existing schemes.

1 Paragraph 61 of HMRC Guidance, ‘Avoidance through the creation and use of capital losses by companies’.

Disclosure of tax avoidance schemes 1.59 We have covered the EU Mandatory Disclosure Regime in further detail in Chapter 4. One of the most significant changes was the introduction in FA 2004 of the rules requiring promoters to inform HMRC of schemes that are taken to, or developed with, clients. Very broadly, the rules operate so that a promoter of a tax scheme has to inform HMRC about the scheme within five days of discussing it with a client. Or, if the arrangements are bespoke to the client’s specific circumstances, the disclosure to HMRC is due within five days of the promoter becoming aware that the client has started implementing the planning. These new disclosure regulations are at FA 2004, s 306 et seq and they perform the invaluable role of ensuring that HMRC gets intelligence about tax planning ideas much earlier than if they were still obliged to wait for the client’s tax return, which could be almost two years after implementation. The legislation is also very flexible as the arrangements that must be disclosed are covered by secondary legislation. The meaning of a notifiable arrangement or proposal is set out in a series of Regulations, including SI 2006/1543, and 50

Corporation tax and chargeable gains 1.59 applies to the taxes specified within. Corporation tax and capital gains tax are within the scope of SI 2006/1543, reg 5(1)(a), and ATED gains are within the scope of SI 2013/2571, reg 4. The arrangements that must be disclosed (in respect of direct taxes1) are (in brief) those that fall within any one or more of the following hallmarks: ●●

arrangements that any hypothetical promoter might be expected to want to keep confidential from other promoters or from HMRC;

●●

arrangements where there is no promoter but a user would want to keep confidential from HMRC;

●●

arrangements that might command a premium fee, meaning broadly a fee contingent upon a tax saving, and including arrangements where a bank might offer ‘off-market’ terms to recognise the tax advantage that the user hopes to obtain;

●●

arrangements involving standardised tax products, such as solutions that do not require any tailoring to the specific client before implementation. This hallmark was revised by SI 2016/99 and now requires that an informed observer could reasonably be expected to conclude that the arrangements have (at least substantially) standardised documentation. The aim of the change is to ensure that minor changes do not result in the hallmark not being in point;

●●

loss schemes designed to provide up-front loss relief for individuals against their income tax or capital gains tax liabilities;

●●

arrangements involving high-value plant or machinery leasing schemes; and

●●

arrangements where employment income is provided through third parties but in such a way that one of the exemptions from the rules in ITEPA 2003, Part 7A applies.

SI 2016/99 introduced a new hallmark covering financial products, defined as loans, shares, derivative contracts, repos, stock-lending arrangements, alternative finance arrangements and contracts which in substance represent the making of a loan, or the advancing or depositing of money. In order for the hallmark to apply, there needs to be a tax advantage that is directly linked to the financial product by reason of containing at least one term which is unlikely to have been included but for the tax advantage, and the arrangement must involve one or more contrived steps without which the tax advantage could not be obtained. While the intention is to ensure that HMRC gets early information about what taxpayers and their advisers are doing, it is important to remember that not all disclosable arrangements will be considered offensive. Indeed, it is assumed 51

1.60 Corporation tax and chargeable gains that a number of inoffensive solutions will also be disclosed, due simply to the inherent difficulty in targeting the hallmarks. HMRC is also looking to influence taxpayer behaviour in a number of ways. For example, the information rules also require HMRC to give promoters a reference number and the users of the schemes are required to show these reference numbers on their tax returns. Many clients are understandably nervous about having to put an entry on the tax return that might be taken to be flagging the fact that they have entered into a tax scheme. Furthermore, the penalty regime under these provisions can be draconian, affecting both promoters and introducers and with penalties up to £1 million available in extreme cases. HMRC has again (as the Inland Revenue did in the 1970s) said that all appropriate cases will be litigated and that there will be no deals or horse trades with taxpayers. So taxpayers can no longer expect a compromise of some sort so that they get part of the tax benefit of any planning, although the main effect of this attitude seems to be a massive backlog of cases that will gave to be decided by the Tribunals. In practice, however, the number of disclosures has been steadily reducing since these rules were enacted in 2004, which could be indicative of a shift in taxpayer behaviour or the increased powers given to HMRC.

1 There are also rules for disclosure in respect of stamp duty land tax, inheritance tax, schemes involving pensions and VAT.

General anti-abuse rule Background 1.60 It was no great surprise that HMRC continued to push for a general anti-avoidance rule, and the Government commissioned a report on such a rule in December 2010, from Graham Aaronson QC. Mr Aaronson and his group of experts reported on 21 November 2011 suggesting that, instead of a general anti-avoidance rule, there should be a general anti-abuse rule, targeted only at the most egregious of tax planning schemes. The issue identified was that a general anti-avoidance rule would be too wide and would have an adverse impact on ordinary commercial planning and tax planning, thus introducing unnecessary uncertainty into the tax system. This was very much the problem identified in 1999, when a general anti-avoidance rule had previously been proposed. Such uncertainty would require substantial extra HMRC resource, either to police the rule or to provide pre-transaction clearances. This was one of the main reasons that the original proposal foundered. 52

Corporation tax and chargeable gains 1.61 The great advantage of Mr Aaronson’s team’s more restrictive proposal was that, by substantially narrowing the target, the rule could be implemented without the requirement for a pre-transaction clearance facility.

Detail 1.61 The legislation, which is at Finance Act 2013, ss 206–215, Sch 43 and came into force on 13 July 2013, applies to: ●●

income tax;

●●

corporation tax (including amounts chargeable as if they were corporation tax or treated as if they were corporation tax, which therefore includes chargeable gains subject to the surcharge on banking companies);

●●

capital gains tax;

●●

petroleum revenue tax;

●●

diverted profits tax;

●●

inheritance tax;

●●

stamp duty land tax; and

●●

annual tax on enveloped dwellings.

The rules apply to abusive tax arrangements. Tax arrangements are those where it would be reasonable to conclude that the avoidance of tax was one of the main purposes of the arrangements. Arrangements are abusive if they ‘cannot reasonably be regarded as a reasonable course of action’ in the context of the relevant tax provisions. The legislation defines this in terms of whether the results of the arrangements are consistent with the principles on which the provisions are based and on their policy objectives, whether the arrangements include contrived or abnormal steps and whether there is an intention to exploit shortcomings in the tax provisions (ie loopholes). The phrase ‘cannot reasonably be regarded as a reasonable course of action’ has often been referred to as ‘the double reasonableness test’. If the GAAR applies, HMRC can make counteracting adjustments to the extent that is just and reasonable. These can apply to any tax to which the GAAR itself applies and can apply to any person, as it is often the case, particularly in group situations, that one person obtains some form of tax advantage due to the actions of another. Where adjustments have been made under these provisions, however, it is possible for affected parties to claim for consequential relieving adjustments to reduce a liability to tax where, otherwise, the GAAR would go beyond the required objective of simply denying the tax advantage sought. 53

1.62 Corporation tax and chargeable gains

GAAR Advisory Panel 1.62 One of the unique features of the GAAR is the GAAR Advisory Panel, a panel of tax and other experts appointed to oversee the legislation. In the context of the application of the GAAR the Panel’s main duties are to review cases, as HMRC is not permitted to invoke the GAAR without a reference to the Panel. Once a case is referred to the Panel, the taxpayers also have the opportunity to make representations to the Panel in respect of the case. The Panel must then report its findings, which do not have to be unanimous. The Panel’s views are, technically, only advisory. This means that HMRC can ignore a finding by the Panel that arrangements were not so abusive as to invoke the GAAR, and try to persuade the tribunals and the courts accordingly. But the tribunals and courts are required by law to take into account the findings of the Panel and would, one assumes, be unlikely to find that the GAAR is in point if HMRC’s own advisory panel has suggested that it is not. In this context, therefore, the GAAR advisory panel is not just there to advise HMRC, but it is also a vital safeguard for taxpayers.

GAAR guidance 1.63 The Panel also has overview of another unique feature of the GAAR legislation, which is the quasi-statutory character of the GAAR guidance. This guidance is written by HMRC, but all the material parts must be approved by the GAAR Advisory Panel before the guidance is published (there is a section purely on the mechanics of the GAAR, which does not have to be approved by the Panel). The intention is that guidance will be updated from time to time (with the latest drafts being published on 28 March 2018 – except Part D which was last published on 31 March 2017), particularly as experience is gathered as to appropriate cases in which to apply the GAAR and, in due course, on the decisions made by tribunals and courts. In the meantime, in any case that goes before them, the tribunals and courts must take into account the guidance that was in force at the time that the tax arrangements were entered into.

Removing the tax cash-flow benefit 1.64 HMRC has also realised that one of the advantages to taxpayers in entering into tax avoidance schemes is cash flow. Taxpayers file their tax returns on the basis that a certain amount of tax is payable and HMRC might challenge the relevant tax planning, but it might take several years for the matter to be resolved, during which time the taxpayer continues to have the benefit of holding on to the cash. It many cases, particularly involving large amounts of money or lengthy periods of time (such as where cases go all the way to the Supreme Court), the cash flow benefit could be substantial even if the substantive tax case were eventually lost. 54

Corporation tax and chargeable gains 1.66 The other practical feature, of course, was that much can happen commercially over a lengthy period of time. HMRC was finding quite regularly that, by the time a tax issue was resolved, the taxpayer concerned was no longer available to pay the tax, perhaps through death or emigration, or because the company had been wound up or gone into liquidation, so there was an absolute loss of tax even if HMRC had won the technical arguments. As a result, measures were enacted in Finance Act 2014 to reduce these advantages.

Follower notices 1.65 Follower notices, allow HMRC to require a taxpayer to correct their tax returns in situations where the arrangements entered into by that taxpayer have been the subject (in HMRC’s opinion) of a final judicial ruling in favour of HMRC. This means a ruling of a court or tribunal which either relates to the same tax arrangements or HMRC considers establishes principles that would apply to the tax arrangements entered into by the relevant taxpayer. The essence of these rules, of course, is that HMRC can force taxpayers to settle where a decision has become final in respect of a particular piece of tax planning, rather than being forced to take each individual case through the courts at considerable expense and, of course, further time passing. Taxpayers can make representations against a follower notice but, if these are rejected, the returns must be amended and the tax paid. If not, the taxpayer can also be subject to a penalty of 50 per cent of the value of the tax advantage. Of course, this does not prevent taxpayers insisting that their case is sufficiently different that they wish to be heard separately by the tribunals or the courts. But it will force people to think much more carefully as to whether the differences between their case and those which have been finally determined are sufficiently material as to justify the risk of a further 50 per cent of the tax becoming payable.

Accelerated payment notices 1.66 HMRC also has the power to issue accelerated payment notices (‘APNs’) which are, as might be inferred from the name, requirements for taxpayers to pay the tax that is at stake in a case, rather than holding on to it until the case is finally determined. This ensures that HMRC effectively removes the tax cash flow advantage from entering into tax planning and also ensures, so far as possible, that the tax will be paid, ie that the taxpayer will not have emigrated or be liquidated or whatever by the time the case is finally settled. 55

1.67 Corporation tax and chargeable gains In general these can only apply where the tax arrangements concerned have been disclosed under the disclosure of tax avoidance schemes regulations, referred to above, or where a GAAR counteraction notice has been given in respect of those arrangements. Once again taxpayers can make representations but, if these are unsuccessful, as is likely to be the case most frequently, the disputed tax must be paid over on account by the taxpayer. If the tax is paid late, the taxpayer is liable to a penalty of up to 15 per cent in 5 per cent tranches. That is, a penalty of 5 per cent of the tax becomes due if payment under the APN is not made within 90 days of the original notice or, if later, within 30 days of HMRC’s determination after a representation. A further penalty of 5 per cent becomes payable if the tax is unpaid more than five months after that date and another penalty of 5 per cent becomes due if the tax remains unpaid six months later, ie 11 months after the date when the tax should originally have been paid.

The Ramsay doctrine 1.67 The Ramsay doctrine arises from the decision in the Ramsay case in 1981 (see 1.56) and the way in which it is to be interpreted has changed a number of times since that first decision. The doctrine can be seen very broadly as an approach to statutory interpretation that allows tax legislation to be interpreted in a way that takes into account the overall result of a series of steps where the result of looking at each step taken individually would be to circumvent the intention of Parliament. The details of the Ramsay case are largely irrelevant. What is important is that there was a self-cancelling, circular scheme which purported to create a capital loss where no economic loss had been suffered. The arrangements were, in the words of the advisers1, ‘a pure tax avoidance scheme and has no commercial justification’ except to provide the company with an allowable loss to offset a gain it had made on a previous commercial transaction. All the transactions were real, the nature of the scheme was that all the steps would be carried through to completion without the need for contractual arrangements and the only economic effect was the payment of fees to the advisers and the bank. The Revenue argued that the scheme should be seen as a seamless whole and that the courts should decide on the basis of the real economic situation, not on the basis that a series of discrete steps, analysed independently, would produce an artificial tax loss. The Law Lords agreed with the Revenue. Lord Wilberforce in the House of Lords said that ‘capital gains tax was created to operate in the real world, not that of make believe … it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences’. 56

Corporation tax and chargeable gains 1.67 He went on to say that the House was entitled to find that such a loss was not what the legislation (or Parliament) intended to relieve: ‘to say that a loss (or gain) which appears to arise at one stage in an indivisible process … is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function’. It is interesting to compare this purposive approach with that of Learned Hand J in the US in Helvering v Gregory 69 F2d 809 (1934, affirmed 293 US 465 (1935); see also Chapter 13), in which he essentially found that a reorganisation transaction with no business purpose was ‘not what the statute means’, ie the statute was not intended to relieve such reorganisations. The ratio for their Lordships’ decision in favour of the Revenue was that ‘it would be wrong to pick out and stop at the one step which produced the loss. The true view regarding the scheme as a whole is that there was neither gain nor loss’ (Lord Wilberforce again). In the 1984 decision in Furniss v Dawson 55 TC 324 (discussed in detail in the introduction to Chapter 13), this principle of looking at the result and not at the separate, indivisible steps was held to apply to linear transactions too, ie the same principle could be applied to a sequence of transactions with real economic consequences, not just to circular, self-cancelling transactions. This case, and the later case of Craven v White 62 TC 1, led to a formulation of the Ramsay approach, largely attributable to Lord Brightman in Furniss v Dawson, that required five factors to be present: ●●

there must be a pre-ordained series of transactions or, as it were, a single composite transaction;

●●

there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax. The fact that the inserted step may have a business effect is not relevant;

●●

the series of steps was, at the time the intermediate (or inserted) transaction was entered into, pre-ordained in order to produce a given result;

●●

there was, at that time, no practical likelihood that the pre-planned events would not take place in the order ordained, so that the intermediate transaction was not even contemplated practically as having an independent life; and

●●

the pre-ordained events did in fact take place.

In Craven v White, the House of Lords found for the taxpayer because the final step in the transaction, a sale to a third party, was not sufficiently certain for the purposes of this formulation. The degree of inevitability, following Lord Brightman’s formulation in Furniss v Dawson, was that the sequence of transactions had to culminate in the disposal to a specific purchaser. 57

1.67 Corporation tax and chargeable gains In Craven v White, the identity of the buyer was uncertain at the time the planning was carried out, so there was not the required degree of inevitability and the taxpayer won his case. This decision, in 1988, and Lord Brightman’s formulation, rather drew the teeth of the Ramsay doctrine for a while, so far as tax planners were concerned. For example, capital gains planning could circumvent the formulation by being carried out before a specific buyer was identified, so there was no pre-ordained sequence of transactions. This all changed in 2001 with the decision in MacNiven v Westmoreland Investments Ltd 73 TC 1. Instead of following the previously well-used formulation, Lord Hoffmann, in the House of Lords, made a distinction between ‘commercial’ and ‘legal’ concepts and seemed, in effect, to be saying that only commercial concepts were open to reinterpretation. Legal concepts were matters that had a specific legal meaning; in the context of tax, this might mean a detailed definition within the tax legislation, what Lord Millett once referred to as ‘closely articulated’ legislation. Looking at this another way, Ribeiro PJ said: ‘The driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.’2 The House of Lords explained this new approach to Ramsay in more detail in the case of Barclays Mercantile Business Finance v Mawson 76 TC 446, decided in November 2004 and supplemented by further obiter in IRC v Scottish Provident Institution 76 TC 538. Lord Hoffmann expanded on the theme in a lecture given in December 2004 and published in 20053. He said that the proper approach to the Ramsay cases is: ●●

the statute is to be interpreted purposively;

●●

the purpose is that of Parliament;

●●

the purpose of Parliament must be assumed to be expressed in the statute, particularly if the legislation is closely articulated;

●●

otherwise, another way to analyse the purpose of the statute may be required. This may equate to the ‘commercial’ interpretation suggested in the Westmoreland Investments case or to some other approach, such as the more purely purposive analyses in Ramsay itself or in Helvering v Gregory;

●●

but there are no definitive Ramsay rules, so that the formulaic approach that followed Craven v White will no longer be viable; and 58

Corporation tax and chargeable gains 1.67 ●●

there are no ‘anti-Ramsay’ bullets, such as irrelevant, but commercially genuine, risk inserted into the planning specifically to get round the formulaic approach by making the transactions less than totally inevitable (as in the Scottish Provident Institution case).

An important point made by Lord Hoffmann relates to the way in which the legislation is written. As he put it: ‘To understand the general economic effect of transactions that one intends to tax is usually relatively easy. To understand the intricate and multifarious forms which some of them can take is often much more difficult. But the Revenue appear to have no faith in the ability or willingness of the courts to recognise the economic effect beneath the varied forms and often prefer to legislate by reference to form rather than substance’. In essence, he was saying that the modern trend to closely articulated legislation often forces the courts to observe the letter of the law, rather than its broader intention (which was precisely the problem highlighted in the recent case of Mayes v HMRC [2011] STC 1269, where the court felt compelled to follow the highly prescriptive rules relating to second-hand insurance policies, rather than to consider what the broader intention of the legislation might have been). He suggests that the better approach might be to legislate less restrictively and for Parliament to trust the courts to give effect to its intention. It is in this arena that the courts would also be able to have regard to a coherent system of taxation. To look at this another way, much recent legislation is in the form of a discrete, partly (or wholly) self-contained tax regime, such as the substantial shareholding exemption4 and the regime for the taxation of intangible fixed assets5, which are also very closely articulated in their structure. Where the courts are considering the application of the Ramsay doctrine, they are restricted in two ways. First, since most of these pieces of legislation have their own specific anti-avoidance rules6, a purposive approach must assume that those rules articulate the areas that Parliament considers to be at risk of abuse. Therefore, if the specific anti-avoidance rules are not applicable, the courts might find it hard to apply a general and non-statutory anti-avoidance rule. Secondly, in so far as the Ramsay approach may be applicable, these self-contained regimes may not permit the wider tax code to be considered, so the coherence of the tax system as a whole must be ignored, although we would assume that it would be right to consider the coherence of the specific tax regime being reviewed. An interesting decision following BMBF was in the case of EDI Services v IRC (No 2) [2006] STC (SCD) 392. This case involved the payment of directors’ bonuses in gold coins in a way that avoided liability to employers’ National Insurance Contributions (‘NICs’) on the basis that the coins constituted 59

1.67 Corporation tax and chargeable gains ‘payments in kind’. The Special Commissioners found for HMRC by both approaches to Ramsay. However, they clearly preferred the purposive approach, which they referred to as the ‘more natural’ approach to Ramsay. By this method, the Special Commissioners found that the mechanism of the bonuses, designed to deliver cash, was not what was intended by the legislation in exempting payments in kind from liability to employers’ NICs, clearly a purposive approach to compare with Lord Wilberforce and Learned Hand. This is, perhaps, also an example of what Lord Hoffmann was referring to, as the legislation in this area might be seen as having been written in broader ‘commercial’ terms, so the Special Commissioners were able to consider the intention of Parliament in terms of the commercial transaction to be relieved (from NIC) and the general coherence of the tax code. In a very recent decision, PA Holdings v HMRC [2011] EWCA Civ 1414, the Court of Appeal decided that dividends paid to employees in lieu of bonuses, in a highly structured and artificial tax avoidance scheme, were also earnings, subject to PAYE and NICs, and not dividends at all (the First-tier and Upper Tribunals had decided the dividends were both earnings and dividends, which meant they had to be taxed as dividends for income purposes). This is a case that is likely to be decided eventually by the Supreme Court, so the result may change, but to determine that legal dividends are earnings and not dividends at all for income tax purposes might be seen as an extreme exposition of the purposive approach. Overall, the Westmoreland Investments decision in 2001, and the 2004 BMBF and SPI decisions moved the Ramsay approach from the somewhat mechanistic approach that applied for many years after Furniss v Dawson and Craven v White, to a more fluid approach that allows the courts to try and divine the intention of Parliament and to interpret the legislation according to the way in which it was drafted. To the extent that the legislation is closely articulated, the courts might be quite restricted in the extent to which they can override the black letter of the legislation. But in other cases, the courts’ discretion in applying a purposive approach is much wider. This is seen in both Tribunal and court decisions, which increasingly now refer to the intention of Parliament to determine how legislation should be interpreted.

1 This was a Rossminster scheme (see above). 2 Both from the Hong Kong case of Collector of Stamp Revenue v Arrowtown Investments Ltd [2003] HKCFA 46. 3 The Roy Goode Memorial Lecture, British Tax Review, May 2005 (Vol 2005, Issue 2, p 197). 4 TCGA 1992, Sch 7AC. 5 Now in CTA 2009, Part 8. 6 See, for example, TCGA 1992, Sch 7AC, para 5 and CTA 2009, ss 803, 864.

60

Corporation tax and chargeable gains 1.68

CONCLUSION 1.68 We have now set the scene for the rest of this book. In the beginning was FA 1965 which introduced both corporation tax and capital gains tax. Both of these have been outlined briefly in this chapter, along with an overview of the most recent and most important change to capital gains tax, the substantial shareholding exemption, so that what follows can be seen in the context of the overall scheme of taxation. What we have also seen is a theme whereby legislation used for one purpose is reused in different contexts, with appropriate adaptations where required. So the original 1962 legislation for short-term gains was used almost wholesale when capital gains tax was introduced in 1965 and the legislation defining groups of companies started in the group relief rules for income losses, but has been reused for capital gains groups and reused twice, for different purposes, in the substantial shareholding exemption legislation. Similarly, in the context of anti-avoidance legislation, the ‘sole or main purpose’ test first appeared in 1960 as part of the transactions in securities rules and the ‘principles and policy objective’ test first appeared in the GAAR, but both have been used repeatedly since in a number of anti-avoidance contexts. Looking at anti-avoidance, the Revenue has veered between highly specific anti-avoidance provisions aimed precisely at particular schemes and much more widely drawn legislation aimed at closing entire classes of schemes. The latter approach has been more prevalent in recent years, along with the information regulations that allow the HMRC to get to know what arrangements are being developed much earlier than used to be the case. This approach was expected to reach its apotheosis with the introduction of the GAAR but, in the five years since its introduction, there have been a raft of new anti-avoidance measures, many of which have emanated from the OECD BEPS project. In parallel with these developments, in recent years the courts, led by Lord Hoffmann, have reinterpreted the Ramsay doctrine, stressing that the courts should consider whether the result claimed by the taxpayer is the result which reflects the purpose of the legislation, as evidenced by the detailed words of the legislation. Where this intention is not clear from the immediate words of the legislation, it may be necessary to consider other factors, such as the commercial transactions to which the legislation is meant to apply, and possibly the coherence of the tax code or the relevant area of the tax code, in order to determine how the relevant provision should be construed. In other words (to follow Ribeiro PJ), were the relevant statutory provisions, construed purposively, intended to apply to the transaction, viewed realistically? This test has also found its way into statute in newer TAARs.

61

Chapter 2

Stamp taxes

A BRIEF HISTORY 2.1 Stamp duty was introduced over 300 years ago, copying a Dutch tax (at a time when England had a Dutch king). Like income tax, it was intended to be a temporary measure to finance a war but, unlike income tax, it did not require annual renewal. A hundred years later, Pitt the Younger described stamp duty as a tax ‘easily raised, widely diffused, pressing little on any particular class’. In other words, the thought was that those who paid the tax would scarcely notice – so it may, perhaps, be thought of as the original stealth tax. Unfortunately, the American colonists had noticed a few years previously: the ‘Boston Tea Party’, an event widely regarded as marking the start of the American War of Independence, was in fact a protest against the imposition of UK stamp duty on documents in the American Colonies. Pitt also commented that stamp duty was ‘safely and expeditiously collected at a small expense’. Government statistics show that stamp duty is by far the cheapest tax to collect, although this may be because the taxpayer and his advisers have to do most of the work in calculating and administering the tax. Stamp duty has always been an impost on certain documents. As the tax evolved it became primarily a charge on documents relating to the transfer or, in some cases, the issue or creation of assets. As the name indicates, payment was (and often still is) evidenced by fixing or embossing stamps on the relevant document. In general, if no document is created, there is no stamp duty. Its range has varied enormously over three centuries. Those whose memories stretch back to the mid-twentieth century may remember the practice of signing receipts across a postage stamp in order to ensure their legal validity, an example of a postage stamp being used for fiscal purposes. Until 1971, bank cheques were also subject to a 2d stamp duty, and the issue of a new chequebook by the bank led to an immediate deduction from one’s bank account! During the latter half of the twentieth century, the scope of stamp duty was steadily reduced, so that now it only applies to documents transferring shares and other securities plus some transfers of partnership interests and the issue of certain bearer securities. 62

Stamp taxes 2.3 In 1986, stamp duty reserve tax (‘SDRT’), was introduced as a tax on agreements to transfer chargeable securities. This was partly an anti-avoidance measure and also in response to market developments which allowed transfer of beneficial ownership of securities without a document. In essence, SDRT stands in the place of stamp duty when there is nothing to stamp. And, as we shall see, SDRT is repaid or cancelled when stamp duty is paid on a document giving effect to the transaction. In 1997, the Government began to increase stamp duty rates on certain assets. However, the yield to the Exchequer did not increase as expected, because avoidance of the tax on larger transactions became the norm. To counter this, stamp duty on property transactions was replaced by stamp duty land tax (‘SDLT’), from 1 December 2003. It can be seen, therefore, that SDLT is also an anti-avoidance measure (as, arguably, was capital gains tax): it has nothing to do with the stamping of documents, its name being merely an historical artefact. From 1 April 2015, transactions in land situated in Scotland became subject to land and buildings transaction tax (‘LBTT’) instead of SDLT. From 1 April 2018, transactions in land situated in Wales became subject to land transaction tax (‘LTT’) instead of SDLT. Stamp duty, SDRT and SDLT, LBTT and now LTT are generally referred to as ‘stamp taxes’ in the minds of many. Because the other four taxes were drawn up as replacements for stamp duty in their respective areas, there are many similarities between the rules for all five. However, there are also major differences, especially in relation to reliefs which may be relevant to reorganisations, reconstructions, mergers and demergers. 2.2 The rest of this chapter outlines the general application of these taxes and highlights reliefs and other matters likely to be of interest in relation to company reorganisations and similar transactions. Space does not permit a comprehensive exploration of the practicalities of dealing with HMRC or many finer technical points. For information on these matters the reader should consult the specialist work Stamp Taxes in Bloomsbury Professional’s Tax Annuals series and, where necessary, Land and Buildings Transaction Tax in Bloomsbury Professional’s Scottish Tax series.

STAMP DUTY AND SDRT General application 2.3 Stamp duty and SDRT are closely intertwined. The general intention of the legislation is that the taxes should be alternatives, so that, at most, only 63

2.4 Stamp taxes one should be payable on any particular transfer. To this end, provided it is done within six years of the agreement, if a document giving effect to an agreement to transfer securities is executed and ‘duly stamped’, this cancels any SDRT charge which would otherwise arise on the agreement. In the rest of this book, unless the context implies otherwise, the term ‘stamp duty’ should be taken to include the SDRT charge which will normally be due unless and until an appropriate document is executed and duly stamped.

Stamp duty 2.4 As noted above, stamp duty now applies only to documents transferring shares and other securities plus some transfers of partnership interests and the issue of certain bearer securities. The issue of shares does not give rise to stamp duty or SDRT liabilities (unless the shares are in bearer form). However, if shares are issued as consideration for a transfer of other shares or securities, the value of the shares issued will be taken into account in determining the stamp duty or SDRT due on the share transfer. No stamp duty or SDRT arises on the redemption or cancellation of shares. However if shares are repurchased, a stamp duty liability arises by virtue of FA 1986, s 66 which treats the Companies House return relating to the repurchase as a transfer document. The legislation is generally silent as to who has to pay the duty (the exceptions are agreements for sale of equitable interests and issues of bearer instruments). In practice, apart from the issue of bearer instruments, it is invariably paid by the person who acquires the shares or securities in order to cancel any SDRT charge and to be able to register ownership of the asset. The original shareholder will usually have no direct stamp tax liability. However any stamp tax costs will play a part in the overall economics of the transaction and so will indirectly affect the original shareholder. There is no direct compulsion to pay stamp duty on transfers. Enforcement is indirect, arising from the fact that a stampable document cannot be used to register title or as evidence in a civil court unless duly stamped (Stamp Act 1891 (‘SA 1891’), ss 14, 17). Stamp duty is chargeable on documents which effect the transfer of ‘stock and marketable securities’, if: ●●

the document is executed in the UK; or

●●

the assets transferred are located in the UK (issued by a UK company or kept on a register in the UK); or

●●

the document relates to ‘any matter or thing to be done in the UK’. 64

Stamp taxes 2.6 The final point is very wide – for example payment of consideration out of a UK bank account has been held to be sufficient to bring the document into charge. However there are no provisions directly enforcing stamp duty and in practice it is virtually unknown for documents to be submitted for stamping unless they relate to shares of UK companies, or shares of foreign companies kept on a UK register. In these cases as noted above, stamping of the transfer document, often on claiming a relief, may be essential to cancel any SDRT charge and to permit registration of the change of shareholder in the books of the company.

Stamp duty reserve tax 2.5 SDRT is chargeable on agreements to transfer ‘chargeable securities’ (FA 1986,s 87). Securities are not ‘chargeable’ unless they have a sufficient connection with the UK, either being issued by a UK registered company (or an SE (Societas Europaea) having its registered office in the UK), or issued by an overseas company but held on a register kept in the UK. Rights over or interests derived from such securities (eg rights to subscribe) are also within the definition. However debt securities are not ‘chargeable’ unless they have certain equity-like characteristics such as: ●●

an interest rate or amount repayable on redemption which is linked to the results of a business or to the value of specific assets; or

●●

an interest rate which is uncommercially high; or

●●

being convertible into other securities or giving entitlement to receive other securities.

Payment and administration 2.6 In practice SDRT is usually only paid on paperless transactions taking place on financial markets or, exceptionally, transfers of UK unit trust units or OEIC shares directly between investors. In these cases, market professionals are responsible for collection and administration of the tax. For private transactions the tax paid is normally stamp duty. However, careful documentation is often needed to ensure that the taxes interact as intended and that any SDRT charge is cancelled. This is especially true when relying on a relief or exemption. Many reliefs apply only to stamp duty; in these cases a formal claim to relief on a duly executed transfer document is essential to cancel the SDRT charge. This applies to the main reliefs likely to be of interest in transactions dealt with in this book – group relief and relief for acquisitions in the course of a reconstruction. In routine cases a document is ‘duly stamped’ by sending it to the Stamp Office with payment of the duty. The Stamp Office embosses a stamp on the document 65

2.7 Stamp taxes to show that the duty has been paid. Where a transfer is for no consideration (or nothing which counts as consideration for stamp duty purposes), it is not necessary to send it to the Stamp Office, as the document is automatically deemed to be duly stamped as soon as it is executed. Where a transfer is for low consideration, it may be possible for a ‘certificate of value’ to be included in the document. If this is validly done, no stamp duty is due and the document is again treated as ‘duly stamped’ as soon as it is executed. For these purposes ‘low consideration’ means £1,000 or less, but in deciding whether this limit has been passed it is necessary to aggregate consideration for linked transactions and to include consideration for certain other assets transferred in the same transaction. Stamp duty is normally due 30 days after execution of the relevant document. Sometimes the amount of consideration is not known when the time comes to pay, for example where it depends on completion accounts. To avoid interest and penalties, it is possible to submit the document by the deadline, with an estimated payment of duty. It is necessary either to ask the Stamp Office to hold on to it until the final figures are known, or to ask for provisional stamping. In the latter case the Stamp Office will require a formal undertaking to return the document for finalising the stamp duty once the numbers are known.

CONSIDERATION 2.7 Both taxes are charged by reference to the consideration given (or deemed given) for the relevant assets, but different definitions of consideration apply to the different taxes. For SDRT purposes, any consideration in money or money’s worth counts, and if the consideration is not money, its market value is used. However for stamp duty, consideration only counts if it comprises cash, debt and/or stocks and securities. The measure of the value of such consideration is the ‘amount or value thereof’. HMRC regard this as meaning the face value of debt created, assumed or released, the amount repayable on maturity of debt securities and the market value of other stock and securities. As a result of the different definitions, the measure of consideration for a transfer of shares may be different for SDRT and stamp duty purposes. Most commonly the stamp duty on a transfer is less than the SDRT would be. For this reason it is often best to create and stamp a transfer document for any agreement to transfer UK shares. As noted at 2.4 this is usually essential where a relief is to be claimed, as most reliefs apply only to stamp duty and not directly to SDRT. Complications arise if the consideration cannot be known with certainty at the time of the transaction. This commonly happens when there is an element of contingency, for example in an earn-out, or where the consideration depends on business results for accounting periods ending at a later date. Two interrelated principles apply to determine the consideration for stamp duty 66

Stamp taxes 2.7 purposes in such cases. Of course if the transaction is exempt from stamp duty or qualifies for a relief, it will not normally be necessary to determine the precise consideration. However sometimes application of these two principles will lead to the conclusion that the consideration (for stamp duty purposes even though not commercially) is zero, which may obviate the need to claim a relief. The first principle is that stamp duty is only chargeable on consideration which is ‘ascertainable’ at the date of the Transfer. This principle is not overtly stated in the legislation, but it is HMRC’s long established interpretation of words now in FA 1999, Sch 13, para 2. Consideration is ascertainable if it is possible to deduce one or more specific figures for it from documents or facts extant at the time of execution of the Transfer. It does not matter whether payment of that particular amount is certain or contingent on future events. The test is whether the amount is capable of being ascertained at the relevant date, not whether it has been ascertained. So, for example, consideration which depends on completion accounts is ascertainable even if it has not been ascertained at the date of completion. In contrast, to the extent that consideration depends on accounts for a period ending after completion, that consideration is not ascertainable. Consideration will commonly be expressed as subject to future events but within specified limits; for example, ‘five times next year’s pre-tax profit up to a maximum of £1 million’. Although actual consideration is not known at the date of completion, it is possible to deduce a specific contingent sum – £1 million – and this will be the consideration for stamp duty purposes. There will be no adjustment of that sum for stamp duty purposes once actual consideration is known; stamp duty will be due on £1 million. Thus, the commercial desire to limit consideration payable under an earn-out or similar arrangement may have the accidental effect of maximising the stamp duty cost. The LM Tenancies case ([1996] STC 880) involved an attempt to render consideration unascertainable, so avoiding stamp duty, but to limit the risk of actually having to pay a high consideration. It did this by linking the consideration to the value, a few days later, of a security with a very stable price. It was held, however, that the consideration was not truly unascertainable and should be taken as the figure based on the value of the security at the date of the Transfer. The second principle is the so-called ‘contingency principle’. This is based on old case law, especially the Underground Electric Railways cases ([1905] 1 KB 174, [1914] 3 KB 210). The principle states that any sum stated to be payable by way of consideration on the happening of some contingency is subject to stamp duty as if certainly payable. Combining this with the question of whether consideration is ascertainable, HMRC consider that, if more than one figure can be deduced, the consideration must be assumed to be the highest of these. So if consideration is expressed as ‘five times next year’s pre-tax profit subject to a minimum of £500,000 and a maximum of £1 million’, stamp 67

2.8 Stamp taxes duty will be chargeable on the higher figure of £1 million, no matter what the actual consideration proves to be.

RELIEFS 2.8 There are numerous reliefs from stamp duty but far fewer from SDRT. If a relief from stamp duty is to be claimed, a formal process applies. It is normally necessary to execute a transfer document which must be sent to the Stamp Office with specified information and supporting documents. The Stamp Office must be asked to ‘adjudicate’ the stamp duty due. Adjudication involves a formal determination of the amount of stamp duty and, where this is required, the document is not ‘duly stamped’ unless it has happened (evidenced by embossing a particular stamp on the document). Until this is done, any SDRT charge arising on the transaction is not cancelled. In contrast with SDLT (and its sibling taxes), there are no provisions for claw-back of reliefs from stamp duty (or SDRT) on transactions in shares and securities. If a transaction qualifies for relief from these taxes, future events do not lead to withdrawal of the relief. The following reliefs are most likely to be of interest in relation to company reorganisations.

Group transfer relief 2.9 Relief from stamp duty under FA 1930, s 42 may be claimed on the transfer of a beneficial interest in assets between associated companies. ●●

‘Company’ for these purposes means a body corporate, incorporated in any country. Thus LLPs and other similar entities formed under foreign law are included.

●●

For two companies to be associated, one must be the parent of the other, or they must have a common corporate parent.

●●

The basic test of being a parent is by reference to direct or indirect ownership of at least 75 per cent of ordinary share capital. Therefore an entity without share capital – for example an LLP – cannot be a subsidiary, it can only be a parent. Furthermore, putting such an entity into the middle of a structure prevents companies below it from being associated with companies above it. Where share ownership is indirect, the normal algebraic rules apply to determine effective percentage ownership. The rules in CTA 2010, Part 5, Chapter 6 (previously ICTA 1988, Sch 18) apply to deny relief where economic rights of shareholders do not match 68

Stamp taxes 2.9 ownership of nominal capital, omitting the paragraphs taking account of potential future changes in rights. The requirement for beneficial ownership/entitlement in these rules is important. As noted below, an arrangement to break the group relationship by disposal of the transferor does not prevent group relief on a prior intra-group Transfer. However, if that arrangement has progressed too far, there may be a risk that the parent company has lost beneficial ownership of the transferor and that the group is therefore broken. Cases such as Wood Preservation Ltd v Prior ([1968] 2 All ER 849) provide guidance on this point. It is important that the necessary group relationship is intact at the time of execution of the Transfer. It is not enough for the companies to be associated only at the time of any agreement to transfer. ●●

If a beneficial interest is to be transferred, the transferor must hold that beneficial interest at the start of the process and the transferee must hold it (even if only briefly) at the end. If the asset is ultimately to be transferred to a third party, care must be taken to ensure that the group companies do nothing in relation to that final disposal which may lead to loss of beneficial ownership until the intra-group Transfer has been completed. Beneficial ownership may be lost, for example, as soon as there is a binding commitment to sell the asset to the third party, even though no payment has been made.

●●

Anti-avoidance rules set out in FA 1967, s 27 deny relief if the Transfer is made in connection with any ‘arrangements’ under which consideration is to be provided or received by a third party, or the transferor and transferee are to cease to be associated by the transferee leaving the group, or the asset being transferred was previously conveyed by anyone other than a group company. HMRC have issued guidance on how they apply them (SP 3/98). This explains that:  ‘arrangements’ is a very wide term, covering informal understandings as well as formal contracts. Clearly any intra-group Transfers should be done at the earliest possible stage, and certainly before any final decision is made as to whether the transferee company will leave the group; 

relief is not denied merely because the transferee obtains third party debt funding to buy the asset, but relief will be denied where the funding arrangement may lead to transfer of the economic risk and reward of ownership of the asset out of the group, such as if the transferee borrows at an economically unsustainable level, or the lender has shareholder-type rights which could allow it to take control of the asset; and



the rule relating to ‘previous conveyance’ was intended to prevent a specific type of avoidance device. Relief will not be denied if the asset was previously transferred into the group from a third party under a Transfer on which stamp duty was paid. 69

2.10 Stamp taxes The following matters often cause confusion: ●●

There is no question of stamp duty group relief being ‘clawed back’. Claw-back is a concept which applies only to SDLT and LBTT. If stamp duty group relief is validly and successfully claimed on a Transfer, events thereafter have no impact on the claim. However, HMRC are entitled to have regard to subsequent events when considering claims, so it is wise to submit group relief claims quickly after the intra-group Transfer.

●●

Group relief will not usually be denied merely because there are plans for the asset itself to leave the group, provided that onward transfer of the asset is subject to stamp duty as normal. However, as noted above, care is needed in relation to the timing of that onward disposal.

●●

No problem is caused by plans to dispose of the transferor, because the legislation specifically refers to the ownership of the transferee, provided those plans have not progressed too far.

●●

A company may repurchase its own shares from a shareholder. This repurchase may qualify for group relief, provided the companies are in the necessary group relationship, subject to the usual anti-avoidance rules.

Reconstruction and acquisition reliefs 2.10 There are two other reliefs in FA 1986, ss 75 and 77 which remove the stamp duty charge for certain Transfers not involving a change in ultimate ownership but which may not qualify for group relief. (There used to be a third relief in FA 1986, s 76 which limited the stamp duty rate to 0.5% where there is a change in economic ownership. This became redundant when the only normal stamp duty rate became 0.5%, and was finally repealed in 2013.)

Reconstruction relief – FA 1986, s 75 2.11 In the heading to the legislation this is described as ‘acquisition relief’ but, because it applies only to schemes of reconstruction,1 it is widely known as ‘reconstruction relief’. The relief reduces stamp duty to zero where, in pursuance of a scheme of reconstruction, a company (B) acquires all or part of the undertaking of another company (A), as shown in Figure 2.1. The consideration for the acquisition must consist of or include the issue of non-redeemable shares by B to all of the shareholders of A (not to A itself). The only other consideration permitted is that B assumes or discharges debts of A (this looks very similar to the conditions for relief under TCGA 1992, s 139: see Chapter 18). 70

Stamp taxes 2.11 Figure 2.1

After the acquisition, the shareholders of B must be the same as those of A, and the proportion of shares in B held by each shareholder must be the same as the proportion of shares in A held by that shareholder. Minor variations in proportions, as a result of the inability to allot fractional shares, for example, are permitted. HMRC insist that the shares be properly issued for these purposes – that is, all formalities to record the shareholders in the statutory books of B must be completed – and shares in B may only be issued to a nominee if the equivalent shares in A were held by the same nominee for the benefit of the same beneficial owner. In determining these proportions, any shares held in treasury by A itself are ignored. In view of the limited application of stamp duty, clearly the relief is only applicable where the undertaking of A consists of or includes stock or marketable securities, or interests in partnerships which hold stock or marketable securities. There is no statutory definition of ‘undertaking’, but tax case precedents indicate that the mere passive holding of assets, as investments for example, does not amount to an undertaking. Furthermore, for the undertaking of A to be ‘transferred’, B must carry it on in much the same form as did A. So, if A holds a portfolio of shares as an investment, or if, after transfer to B, the shares are held as investments, relief is not likely to be available. However, if A carries on a share dealing business and, after the transfer, B also carries on a share dealing business, the Transfer could qualify for relief. HMRC also accept that acting as the holding company of controlling interests in one or more trading companies may amount to an undertaking, providing the holding company does in practice act as a parent company, taking an appropriate interest in the running of the group. So, if A holds a controlling interest in a trading company, this may amount to an undertaking and the relief may apply on a transfer of the shares of the trading company to B. It is also the view of HMRC, again supported by precedent, that a transaction is not a reconstruction if there is any appreciable change in the ultimate ownership of the assets. The legislation does not explicitly require that the shares issued by B should be of the same class as each other or as the shares in A. However, if 71

2.12 Stamp taxes shares of different classes are issued and if these give the shareholders different economic rights, the transaction may not be a reconstruction and so may not qualify for relief.

1 The definition of a scheme of reconstruction for the purposes of stamp taxes does not follow the capital gains definition (at TCGA 1992, Sch 5AA). Thus a transaction may qualify as a scheme of reconstruction for capital gains purposes but not for stamp tax purposes (although vice versa is unlikely). This subject is covered in more detail in Chapter 15.

Relief for insertion of new holding company – FA 1986, s 77 2.12 In the heading to the legislation this is also described as a relief for acquisition, but the paragraph heading above is more accurate. No stamp duty is chargeable on a Transfer of shares in one company (A) to another company (B) where the Transfer forms part of an arrangement for B to acquire all of the shares in A, provided: (1) the only consideration is the issue of shares in B to shareholders of A; (2)

every shareholder of A immediately before the acquisition is a shareholder of B after the acquisition, and holds the same proportion of shares in B as previously held in A;

(3) if A has shares of different classes, the classes and relative proportions by number of each class are replicated in B; and (4) the proportion of shares of B of any particular class, in issue or held by any particular shareholder, is the same as the proportion of shares of that class in A, in issue or held by that shareholder, immediately before the acquisition. Figure 2.2

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Stamp taxes 2.12 Readers will see that the transaction description is a specific form of share-for-share exchange, which is discussed in more detail in Chapter 8. From 29 June 2016, this relief may not be available if there will be a change of control in company B, following the enactment of FA 1986, s 77A by FA 2016, s 137 (see 2.14). The reference to different share classes relates to the rights and characteristics of the shares, not particularly how they are labelled. So, if shares are labelled class A and class B purely to identify by which member of a consortium they are held and if they have identical rights etc, they will not be regarded as being of different classes for stamp duty purposes. But shares which have different voting or dividend rights or different nominal values will be regarded as being of different classes. The transaction must be part of the acquisition of all of the target company’s share capital. If B already holds some shares in A (for example, after stake-building in a quoted company) or if any shares of A remain with another shareholder (for example, a dissenting shareholder), the relief will not be available. In practice, therefore, the relief is only of use for insertion of a new holding company by a 100 per cent shareholder or by agreement amongst a group of shareholders with 100 per cent between them. This is most commonly done as a first step in a further reconstruction or reorganisation, or perhaps to put a ‘clean’ company at the top of a group prior to a stock market initial public offering. Figure 2.3

If insertion of a new holding company proceeds by way of a cancellation and reissue of shares in accordance with Companies Act 2006, Parts 26 and 27, there is no transfer or repurchase of shares and no stamp duty liability normally arises. In particular, the Court Order sanctioning the transaction and giving rise to the cancellation of shares in A is not a transfer document and is not subject to stamp duty. Therefore there should be no need to claim relief in such a case. 73

2.13 Stamp taxes

Territorial scope of reliefs 2.13 There is no requirement that the acquiring company be UK incorporated in order to obtain relief, and it is not uncommon to use a company incorporated overseas. However, the company law system in the overseas country must be sufficiently similar to that of the UK, to be able to say that the shares issued are non-redeemable ordinary shares of the same classes as the shares transferred (see below).

Anti-avoidance 2.14 These reliefs are subject to a general anti-avoidance condition, that the acquisition must be for bona fide commercial purposes and not be part of a scheme or arrangement which has avoidance of stamp duty, income tax, corporation tax or capital gains tax as a main purpose. In many cases, taxpayers will seek advance clearance from HMRC that the reconstruction is for bona fide commercial purposes and not part of a scheme of arrangement for the avoidance of capital gains tax or corporation tax for direct tax purposes (see Chapter 14). If no clearance is obtained in respect of the capital gains provisions, relief may still be available, but it will be necessary to provide HMRC with further information to satisfy them on this point. For many years where such clearance has been given, this has been regarded as proving that the transaction is not part of an offending scheme or arrangement for stamp duty purposes. This might be regarded as surprising as the officials dealing with clearance applications are not generally stamp tax experts. Possibly in recognition of this, a new anti-avoidance provision (FA 1986, s 77A introduced by FA 2016, s 137) denies relief under FA 1986, s 77 if there are ‘disqualifying arrangements’ at the time of execution of the transfer. Disqualifying arrangements are arrangements for particular persons other than shareholders of the target company to obtain control of the acquiring company. In other words, if the insertion of the new holding company is a step in a larger scheme to transfer economic ownership of the target company to someone else, relief will not be available. This appears to be aimed at a previously fairly common arrangement under which a new non-UK incorporated company is inserted above a UK company, prior to sale of the shares of the new holding company to a third party. Because the new holding company is not UK incorporated, this sale can be achieved free of UK stamp duty. The reference in the legislation to arrangements to transfer control to ‘particular’ persons appears to leave open the possibility of obtaining relief where the new holding company is inserted prior to a stock market offering. Relief may also still be available when the new holding company is inserted in preparation for a possible future sale to third parties if those third parties have not yet 74

Stamp taxes 2.16 been identified or negotiations are not sufficiently advanced to be regarded as amounting to arrangements. There are also provisions in the legislation to ensure that the anti-avoidance rule does not deny relief which would otherwise be due in mergers (see Chapter 19).

SDLT Scope and general application 2.15 SDLT is chargeable only on transactions in land situated in England and Northern Ireland (FA 2003, Part 4). It follows that if there are no transactions in land, or if the only land involved is outside these countries, no SDLT charge can arise. However, if a transaction leads to a change of control of a company which owns UK land, or even a change in the relative economic rights of shareholders who exercise control, this may lead to retrospective withdrawal of certain SDLT reliefs previously claimed (see below). It is therefore important to check the history of any UK land held by companies involved in the transaction. Apart from transitional rules applying to transactions spanning the 2003 commencement date for SDLT, as well as the 2015 LBTT and 2018 LTT start dates, plus an abstruse provision designed to prevent double taxation on transfers of partnership interests, there is no interaction between SDLT and the other stamp taxes. Transactions in shares and securities do not directly give rise to SDLT charges – unlike many other jurisdictions, the UK has no ‘land-rich company’ rules for example – although as noted above a transaction in shares and securities may lead to retrospective withdrawal of SDLT reliefs previously claimed.

Consideration 2.16 SDLT is charged by reference to the consideration given (or deemed given). Consideration may comprise capital sums (whether for transfer of an existing interest or creation of a new one) and/or rent if a lease or tenancy is created or changed. Most consideration in money or money’s worth counts, and if the consideration is not money, its market value is used, subject to valuation rules and exceptions contained in FA 2003, Sch 4. For example, in some very restricted circumstances, consideration in the form of carrying out works on land is ignored. The rules governing consideration for stamp duty purposes have no application in relation to SDLT. If, for any reason, the final consideration is not known when the time comes to submit the SDLT return, a reasonable estimate must 75

2.16 Stamp taxes be used. A further return must then be submitted, with adjustment of the SDLT paid, once the figures are settled. In some circumstances, where payment of consideration is deferred, it may be possible also to defer payment of the related SDLT. However, application for such deferral must be made no later than the due date for the SDLT return. An SDLT return is normally due and payment of the tax required 14 days after the effective date of the transaction. For transactions in purely residential land with an effective date on or after 4 December 2014, SDLT is charged on all consideration other than rent on a progressive basis. The first £125,000 of consideration is charged at zero rate and amounts above this figure are charged at increasing rates as follows: Consideration (£) First £125,000 Next £125,000 Next £675,000 Next £575,000 Everything in excess of £1,500,000

Purely residential property 0%2 2%2 5%1,2 10%1,2 12%1,2

1 A punitive rate of 15% applies where residential property with a value more than £500,000 is acquired through certain non-natural persons: FA 2003, Sch 4A. 2 These rates are increased by 3% for purchase of second homes and buy to let properties from 1 April 2016: FA 2003, Sch 4ZA.

For transactions in non-residential or mixed use land prior to 17 March 2016, SDLT was still charged on all consideration other than rent at a single fixed rate between 1% and 4% (the so called ‘slab’ system). The rate was determined by the aggregate amount of such consideration as follows: Consideration (£) Not exceeding £150,000 £150,001 to £250,000 £250,001 to £500,000 Exceeding £500,000

Non-residential or mixed property 0%1 1% 3% 4%

1 For transactions substantially performed before 17 March 2016, 1% in the case of grant of a lease of non-residential or mixed property with a yearly rent of £1,000 or more attributable to the non-residential part.

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Stamp taxes 2.18 However, for transactions which are substantially performed on or after 17 March 2016, SDLT is also charged on a progressive basis on non-residential and mixed property as shown in this table: Consideration (£) First £150,000 Next £100,000 Everything in excess of £250,000

Non-residential or mixed property 0% 2% 5%

SDLT is also charged on rent on a new lease or in some cases on increases in rent of an existing lease. However, the transfer of an existing lease will not normally give rise to SDLT on rent unless a relief was claimed when the lease was granted. For further details, see Stamp Taxes in Bloomsbury Professional’s Tax Annuals series.

Non-market value consideration 2.17 In general, as above, SDLT is charged on the actual consideration given for a transaction in land. Thus, for example, if there is no consideration, there will be no charge to SDLT. However, where the transferee is a company and is connected with the transferor, the actual consideration is replaced by the market value of the assets in question, if higher (FA 2003, s 53). So, in general, donating land into a company will carry an SDLT charge based on the market value of the land. This rule does not apply, however, where the exceptions listed in FA 2003, s 54 are in point. In terms of relevance to this book, the market value rule does not apply if the transfer is by way of a distribution from a transferor company, including a distribution in a winding up (FA 2003, s 54(4)). However, this exception does not apply if the property in question, or a superior interest in it, has previously been the subject of a group relief claim. Additionally, if there is more than one vendor or purchaser in a connected party transaction, this can affect the calculation of the tax, because of the rules for partnerships in FA 2003, Sch 15. Where this Schedule applies, all consideration given is ignored and the tax is calculated by reference to the formula in FA 2003, Sch 15, Part 3. This frequently gives ‘relief’ from a charge to tax, even though the Schedule is an anti-avoidance provision in its own right.

Reliefs 2.18 As with stamp duty, so with SDLT, some transactions are automatically exempt and there are reliefs which apply to others. In general land transactions for which there is no or low consideration (in a straightforward case, 77

2.19 Stamp taxes less than £40,000) are exempt and do not give rise to compliance obligations beyond the keeping of appropriate records. However a transfer to a connected company is deemed to be for at least market value and so will not generally be exempt. Even if no SDLT is payable, there remains an obligation to submit an SDLT return for any transaction which is not exempt. Reliefs must generally be claimed by submission of a return. The SDLT reliefs most likely to be of interest are equivalent to those which apply to stamp duty – group, reconstruction and acquisition reliefs. The main legislation is in FA 2003, Sch 7. The group and reconstruction reliefs and general conditions to qualify for them are much the same as for stamp duty, as outlined above. In addition there is a relief (‘acquisition relief’) which reduces the rate of SDLT to 0.5 per cent where a company acquires all or part of the undertaking of another company (the Target), without maintaining the same economic ownership as required for the other reliefs. Acquisition relief applies if the only consideration is the issue of non-redeemable shares to the Target or some or all of the Target’s shareholders, plus if required the assumption or discharge of debt of the Target and/or cash not exceeding 10 per cent of the nominal value of the shares issued.

ANTI-AVOIDANCE General anti-avoidance rules 2.19 The SDLT rules contain more stringent anti-avoidance provisions than the stamp duty rules, including a general anti-avoidance rule, at FA 2003, s 75A. This charges SDLT on the greatest amount of consideration paid by anyone or received by or on behalf of the transferor in a transaction, if this is greater than the SDLT actually paid. The test for application of this rule is entirely objective; it applies in any situation where there are ‘a number of transactions’, unless these fall within a very limited range of exceptions listed in the legislation. There is no need for an avoidance motive to be proved. It could therefore apply to an entirely innocent transaction which just happens to lead to a reduced SDLT charge. HMRC have indicated their intention to apply the rule only where there is avoidance, but this does leave HMRC as the final arbiter of what amounts to avoidance. SDLT also comes within the scope of the General Anti-Abuse Rule (‘GAAR’) in FA 2013, ss 206–215.

Denial of reliefs 2.20 Relief for transfers within a group or as part of a reorganisation is denied if the transfer forms part of arrangements, a main purpose of which is the avoidance of SDLT, stamp duty or any of the direct taxes. 78

Stamp taxes 2.22 Relief is also denied if there are arrangements in place at the time of the intra-group transfer or reorganisation for the transferee company to leave the transferor company’s group.

Clawback of reliefs 2.21 Where relief has been claimed under FA 2003, Sch 7 (group, reconstruction and acquisition reliefs on transfer or grant of an interest in land), it may be withdrawn if, within three years of the transfer (or later, without time limit, under arrangements entered into within the three year period), control of the transferee changes or it ceases to be within the same 75 per cent corporate group as the transferor. Alternatively, where such relief has been claimed on the grant of a lease, a proportion of the relief may be effectively withdrawn at any time if the lease itself is transferred, unless that transfer qualifies for relief. Detailed analysis of the circumstances in which SDLT relief may be clawed back is beyond the scope of this book. If there appears to be a risk of claw-back, further research or advice will be needed. In the case of group relief, claw-back is triggered if the transferee leaves the transferor’s group while it or a relevant associated company still owns the property or an interest derived from it. Claw-back is not triggered by the transferor leaving the group, but if that happens, a subsequent change of control of the transferee within the claw-back period, whether direct or indirect, will lead to withdrawal of the relief. In the case of the other FA 2003, Sch 7 reliefs, claw-back occurs if control of the acquiring company changes while it or a relevant associated company still owns the property or an interest derived from it.

Disclosure of tax avoidance schemes 2.22 SDLT is subject to the rules for Disclosure of Tax Avoidance Schemes (‘DOTAS’) in FA 2004, Part 7 but with its own rules for identifying notifiable schemes. There is no reference to the ‘hallmarks’ used to identify notifiable schemes in relation to other taxes. A scheme is notifiable if a main benefit of the arrangements is the obtaining of an SDLT advantage, unless it falls within specific exclusions set out in the regulations. If a transaction gives rise to reduced SDLT costs in comparison with an alternative way of achieving the same economic result, it will be necessary to consider whether the DOTAS rules apply. (Neither stamp duty nor SDRT are currently within the DOTAS rules.)

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2.23 Stamp taxes

LBTT Scope and general application 2.23 From 1 April 2015 (the Start Date) transactions in land situated in Scotland ceased to be liable to SDLT and instead fall within the ambit of LBTT. This tax is administered by Revenue Scotland and collected for the Scottish Government. There are detailed transitional rules governing transactions which began before the Start Date but are completed on or after that date. Broadly speaking, if the effective date of a transaction (usually the date of substantial performance) is on or after the Start Date, it will be within the scope of LBTT. Otherwise, SDLT will apply, even if formal completion of the transaction occurs after the Start Date. However, a contract entered into on or before 1 May 2012 will normally be wholly within the SDLT rules, even if the effective date is on or after the Start Date. It will be important to check the detailed rules (Scotland Act 2012, s 29) in each case. The LBTT rules are in the Land and Buildings Transaction Tax (Scotland) Act 2013. Many of the rules are the same as the equivalent SDLT provisions, but there are some important differences so again it will be important to seek specific advice for each transaction. LBTT is charged on consideration other than rent on a progressive basis for both residential and non-residential property, but the rates and bands are different. Consideration (£) First £145,000 Next £105,000 Next £75,000 Next £325,000 Everything in excess of £750,000

Residential property 0% 2% 5% 10% 12%

Consideration (£) First £150,000 Next £200,000 Everything in excess of £350,000

Non-residential property 0% 3% 4.5%

The Scottish Budget 2019 to 2020 announced that legislation will be introduced to provide that, from 25 January 2019, the lower rate of non-residential LBTT will be reduced from 3% to 1%, the upper rate will be increased

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Stamp taxes 2.25 from 4.5% to 5%, and the starting threshold of the upper rate will be reduced so that it applies from above £250,000 instead of £350,000. Purchase Price Not more than £150,000 £150,001 to £250,000 Over £250,000

LBTT Rate 0% 1% 5%

The new rates will not apply to transactions where the effective date is on or after 25 January 2019 if contracts have been entered into prior to 12 December 2018.

Additional dwellings supplement 2.24 On 1 April 2016, the LBTT Additional dwelling supplement (ADS) came into force, payable on the total purchase price of an additional dwelling of £40,000 or more. ADS is 3% of the ‘relevant consideration’ (usually the purchase price) but is not payable on any non-dwelling element of the purchase. The Scottish Budget 2019 to 2020 announced that legislation will be introduced to provide that, from 25 January 2019, ADS will be charged at 4% of the total purchase price of the dwelling. The new rates will not apply to transaction where the effective date is on or after 25 January 2019 if contracts have been entered into prior to 12 December 2018. When a lease of non-residential property is granted at rent, LBTT is payable on the lifetime rent amounts, as is the case with SDLT. However in relation to LBTT there is then an obligation to submit returns every three years until the lease ends or is disposed of and pay any additional LBTT falling due as a result of rent increases or other changes.

ANTI-AVOIDANCE 2.25 The SDLT-specific anti-avoidance rule (FA 2003, s 75A) is not reproduced in the LBTT legislation. Instead, the Scottish tax authority relies on a General Anti-Avoidance Rule, similar to the GAAR which applies to SDLT and most UK-wide taxes (see 2.19). The Scottish Ministers have the power to make regulations to treat the transfer of a holding in a residential property company as if it was a transfer of the underlying property (Land and Buildings Transaction Tax (Scotland) Act 2013, s 47). At the time of writing (August 2020), this power had not been invoked. 81

2.26 Stamp taxes

LTT Scope and general application 2.26 From 1 April 2018 (the Start Date), transactions in land situated in Wales ceased to be liable to SDLT and instead fall within the ambit of LTT. This tax is administered by the Welsh Revenue Authority and collected for the Welsh Government. There are detailed transitional rules governing transactions which began before the Start Date but are completed on or after that date. Broadly speaking, if the effective date of a transaction (usually the date of substantial performance) is on or after the Start Date, it will be within the scope of LTT. Otherwise, SDLT will apply, even if formal completion of the transaction occurs after the Start Date. However, a contract entered into on or before 17 December 2014 will normally be wholly within the SDLT rules, even if the effective date is on or after the Start Date. It will be important to check the detailed rules (Wales Act 2014, s 16(5), (6)) in each case. The LTT rules are in the Land Transaction Tax and Anti-avoidance of Devolved Taxes (Wales) Act 2017. Many of the rules are the same as the equivalent SDLT provisions, but there are some important differences so again it will be important to seek specific advice for each transaction. LTT is charged on consideration other than rent on a progressive basis for both residential and non-residential property, but the rates and bands are different.

Main residential tax rates 2.27 When you buy a residential property (freehold or leasehold) the following rates will apply to the portion of the price you pay in each band. Price threshold The portion up to and including £180,000 The portion over £180,000 up to and including £250,000 The portion over £250,000 up to and including £400,000 The portion over £400,000 up to and including £750,000 The portion over £750,000 up to and including £1,500,000 The portion over £1,500,000

LTT rate 0% 3.5% 5% 7.5% 10% 12%

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Stamp taxes 2.30

Higher residential tax rates 2.28 When you buy a residential property and you already own one or more residential properties you may need to pay the higher residential rates. The rates are an additional 3% of the whole of the purchase price. Like SDLT, but unlike LBTT, the Higher rates only apply if the property is wholly residential.

Non-residential property tax rates 2.29 When you buy non-residential property (freehold or leasehold) such as shops, offices, or agricultural land the following rates will apply to the portion of the price you pay in each band. Price threshold The portion up to and including £150,000 The portion over £150,000 up to and including £250,000 The portion over £250,000 up to and including £1,000,000 The portion over £1,000,000

LTT rate 0% 1% 5% 6%

ANTI-AVOIDANCE 2.30 The SDLT-specific anti-avoidance rule (FA 2003, s 75A) is not reproduced in the LTT legislation. Instead, the Welsh Revenue authority relies on a General Anti-Avoidance Rule, similar to the GAAR which applies to SDLT and most UK-wide taxes (see 2.19). The Welsh GAAR is contained in Tax Collection and Management (Wales) Act 2016, Part 3A (ss 81A–81I).

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Chapter 3

Value added tax

THE VAT SYSTEM IN OUTLINE 3.1 Value added tax (‘VAT’) is a tax on gross turnover. It is therefore fundamentally different from income tax, corporation tax and capital gains tax, which are taxes on net income or net gains. The concept of a ‘supply’ is cardinal. Essentially anything which a person carrying on a business does, in the course or furtherance of that business, for a consideration counts, for VAT, either as a ‘supply of goods’ or a ‘supply of services’. ‘Supply of goods’ is largely self-explanatory, but it also includes supplies of a major interest in land. A ‘supply of services’ is anything else, in other words anything, other than a supply of goods, done by the business for a consideration. Having ascertained that there is a supply, one then has to categorise it for VAT. There are four main categories of supply, namely: 1.

Standard-rated, where a supplier has to pay VAT (‘output VAT’) at 20% to HMRC on the price charged. The way VAT legislation works is that any supply is standard-rated unless the legislation specifically places it in another category. A considerable majority of business supplies are standard-rated.

2.

Reduced-rate, where the supplier has to pay output VAT but at 5% rather than 20%. A few socially desirable supplies fall into this category, such as residential conversion work, the sale of children’s car seats and so on: reduced-rate supplies can be ignored for the purposes of this book.

3.

Zero-rated: the supplier pays no output VAT. Technically zero-rated supplies are taxable for VAT but at a rate of 0%. Zero-rated supplies are again of the socially desired type and include most food – but not catering – and some drink, prescribed medicines, books, and new dwellings: zero-rated supplies will not often be relevant in the case of the transactions dealt with in this book. Businesses that make zero-rated supplies can recover the input VAT on costs related to making these supplies.

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Value added tax 3.2 4.

Exempt supplies. On these, again, the supplier charges no output VAT, as they are not treated as taxable supplies. Exempt supplies are chiefly in the financial sector, for example the sale of existing shares or securities, the provision of loans at interest and insurance. Private education and private health are also included, and so are (with various exceptions) supplies of land and buildings. Exempt supplies feature very frequently in company reorganisations, as is explained in the VAT sections of the chapters. Businesses making exempt supplies are not able to recover input VAT on associated costs.

It is important to get the jargon right: standard-rated, reduced-rate and zero-rated supplies are all called ‘taxable supplies’ – even though zero-rated supplies do not in fact attract VAT at all. In addition, there are ‘supplies’ which are ‘outside the scope of’ VAT. Again, no output VAT has to be accounted for on them. There are two main categories: ●●

Transfers of a business as going concerns (‘TOGCs’). These are frequently encountered in this book. The main rules about TOGCs are set out in this chapter, and where supplies constitute TOGCs that is explained in the VAT section to the relevant chapter.

●●

Many supplies with a foreign element. For example, a supply of services to a business customer in the EU (but not the UK), or to any customer outside the EU, is generally outside the scope of UK VAT and the supplier does not have to account for any output VAT. VAT implications of transactions with a foreign element are explained further in 20.67, 26.64 and 27.31.

Input VAT 3.2 The almost unique feature of VAT law is the ability of businesses to obtain refunds of their ‘input VAT’, namely the VAT charged to them on purchases of standard-rated or reduced-rate goods or services. Essentially a business is entitled to a refund from HMRC of the input VAT it incurs for the purpose of making its own onward taxable (i.e. standard-rated, reduced-rate or zero-rated) supplies. Most persons in business in the UK make only taxable supplies and can therefore, if registered, obtain a refund of all their input VAT (except for input VAT on a few items where there is a general prohibition on refund, such as cars (generally) and business entertainment expenses). The input tax is deducted from the output tax due on the VAT return, with the net amount paid to HMRC. In some cases, the input tax will exceed the output tax and the business will receive a refund from HMRC. A person cannot obtain a refund of input VAT insofar as it is run up by him for the purpose of making his own onward exempt supplies. A person who makes 85

3.3 Value added tax both taxable and exempt supplies (and most persons in business in the financial sector make predominantly exempt supplies but also some taxable supplies) is called ‘partially exempt’. One then has to grapple with the niceties of the VAT rules on partial exemption. In very broad outline: ●●

input VAT run up by the person on expenses incurred wholly for the purpose of making his onward taxable supplies is fully refunded by HMRC to him; and

●●

input VAT run up by him on expenses incurred wholly for the purpose of making his onward exempt supplies is, in principle, not refunded by HMRC to him.

That leaves input VAT on expenses run up for the purposes of making both taxable supplies and exempt supplies. This is called ‘residual’ or ‘general overhead’ input VAT, and types of expense which frequently fall into this category are auditor’s fees, the telephone bill and office rent. The VAT attributable to making exempt supplies, however, can be recovered in full if the total input tax is within prescribed ‘de minimis limits’. To be within the de minimis limits, the amount of exempt input VAT must not exceed either of the following limits: ●●

£625 per month on average (£1,875 per quarter or £7,500 per annum); and

●●

50% of the total input VAT (the VAT on purchases relating to taxable supplies should always be greater than the VAT on exempt supplies to pass this test).

If either of these limits is exceeded, it will not be possible to recover the exempt input VAT. HMRC is obliged to refund a proportion of the input VAT, but the position can become quite complicated. There is some explanation of it in 8.24.

Compliance 3.3 A person does not have to pay output VAT unless he is registered, or should have registered, for VAT. And it is only registered persons who can be entitled to refunds of input VAT. Currently a person must register if his annual ‘taxable’ turnover exceeds £85,000 pa in any rolling 12-month period. A person who makes taxable supplies is always free to register below this threshold if he wishes to and is known as a voluntary registration. It will generally be in his interest to do so if the bulk of his customers are business customers who can obtain refunds of input VAT: they will not mind much being charged output 86

Value added tax 3.4 VAT, and the supplier will be entitled to a refund of input VAT on his own purchases. A person who is registered for VAT generally has to submit a VAT return electronically, with any payment due, 7 days after the end of the month following their VAT period, showing the output VAT due from him and the input VAT which he is entitled to reclaim. If his input VAT exceeds his output VAT, HMRC must refund him the difference. Persons with annual VAT bills of more than £2.3 million have to pay VAT every month; at the end of each of the other eight months of the year they must pay a sum on account of their VAT liability for the quarter, based on the VAT due in the previous year.

The European dimension 3.4 VAT is often called a ‘European tax’. It is important to understand what this means and what it does not mean. ●●

The European Union requires all Member States to levy a value added tax.

●●

The EU sets out, currently chiefly in Council Directive 2006/112/EC of 28 November 2006, the main rules of the VAT that Member States must levy. All Member States’ VAT law must comply with this Directive.

●●

Member States are expected to have their own VAT legislation: the Directives are not intended to render domestic legislation unnecessary. However, Member States’ VAT legislation, although it will go into more detail than the Directives, must not conflict with them.

●●

Tribunals and courts in the Member State must, so far as possible, construe their domestic legislation so as to not conflict with the Directives.

●●

Where the domestic legislation does conflict with a Directive the Directive generally has ‘direct effect’, and overrides the domestic legislation. Tribunals and courts in the Member State must give effect to this. It is not uncommon for a tribunal or court to hold that the domestic legislation does conflict and so to give overriding effect to the Directive.

●●

Where the interpretation or effect of a Directive is unclear, tribunals and courts can, indeed must, refer the matter to the European Court of Justice in Luxembourg for a binding ruling. The ECJ has a history of interpreting the Directives widely, giving less freedom to domestic VAT legislation to elaborate it. Following the end of the implementation period on 31 December 2020 the UK courts will no longer be subject to the jurisdiction of the ECJ.

87

3.5 Value added tax

VAT AND COMPANY REORGANISATIONS 3.5 It is not common for any of the transactions described in this book to give rise to output VAT. This is because, even where the maker of the supply is established in the UK and is carrying on a relevant business for VAT, the transaction will almost always be one of the following: ●●

an exempt supply, as where a shareholder, in the course of a business carried on by him, disposes of shares for consideration to an acquirer who belongs in the UK or a private acquirer who belongs elsewhere in the EU: Value Added Tax Act 1994 (‘VATA 1994’), Sch 9, Group 5, Item 6;

●●

outside the scope of UK VAT (but effectively an exempt supply), as where a shareholder, in the course of a business carried on by him, disposes of shares for a consideration to a business acquirer who belongs in another EU Member State: VATA 1994, s 7A;

●●

outside the scope of UK VAT with a right of recovery (in practice, much the same as a zero-rated supply), as where a shareholder, in the course of a business carried on by him, disposes of shares for a consideration to an acquirer who belongs outside the EU: VATA 1994, s 7A, Sch 4A, para 16; VAT (Input Tax (Specified Supplies) Order 1999, SI 1999/3121;

●●

not (from the shareholder’s point of view) a supply for VAT, as being the acquisition of shares or most variations of rights attaching to shares;

●●

not a supply for VAT, as being (from the issuing company’s point of view) the issuing of shares; as we will see, this is not a supply by the issuing company;

●●

not a supply for VAT, as being (from both parties’ point of view) the making of some form of distribution by a company. This generally, as we will see, falls into the not-a-supply category;

●●

outside the scope of VAT as being a transfer of a business as a going concern: VAT (Special Provisions) Order 1995, SI 1995/1268, art 5(1)–(3). As we will see, where a transfer of a business takes place as part of a reconstruction, the transfer generally falls within this provision;

●●

not a supply for VAT, as being something which a person does which is not in the course of any business being carried on by him. This is common in the case of transfers of shares by shareholders; many shareholders, particularly if individuals or private trusts, are investors but are not, as shareholders, carrying on any business. The question of whether a person who has a shareholding activity is carrying on a business is considered below.

88

Value added tax 3.6 In the case of the last five bullet points, the person makes no supply and there is no figure to be inserted in the outputs box (Box 6) of his VAT return, if he makes VAT returns. The main VAT issue which does arise in practice in the case of the transactions examined in this book is the participant’s input VAT recovery position, and in particular the recoverability of input VAT on the expenses that he incurs for the purpose of the transaction. Generally these will be legal, accountancy, bankers’, valuers’ and other professional fees. This is tackled transaction by transaction in the following chapters. Bear in mind, however, that a person who is not carrying on a relevant business is rarely entitled to any refund of any input VAT.

Does a holding company carry on a relevant business for VAT? 3.6 A question that is relevant throughout this book and which it is convenient to tackle here is whether a person who holds shares in a company is carrying on a business (or to use the terminology of the EU Directive 2006/112/EC, an economic activity) in relation to those shares. If he is not, any input VAT he incurs in connection with them is not incurred for the purpose of any business activity and will ordinarily be irrecoverable. A person who holds shares does not ipso facto carry on a business for VAT purposes. Most shareholders who are individuals do not: so also the great majority of family trusts and charitable trusts, as in the case of The Wellcome Trust Limited v Customs & Excise Commissioners [1996] STC 945, ECJ. This case shows that a mere investment activity, even if carried out on a very major scale (the Trust had funds of about £5 billion) and in a ‘business-like’ way, does not constitute a business. In contrast, it is accepted that a share dealer carries on a business. In the case of a corporate shareholder, again the mere holding of shares, even in a 100 per cent subsidiary where the parent is strongly interested in its performance, does not constitute a business: Polysar Investments Netherlands BV v Inspecteur der Invoerrechten en Accijnzen [1993] STC 222, ECJ. However, it is perfectly possible for a holding company to carry on a relevant business in relation to its subsidiaries, and there has been a good deal of case law in this area. For example: ●●

where the holding company provides, say, management, bookkeeping or marketing services to the subsidiary for a taxable (in VAT terms) fee: Cibo Participations SA v Directeur régional des impôts du Nord-Pas-de-Calais [2002] STC 460, ECJ, Skatteverket v AB SKF [2010]

89

3.7 Value added tax STC 419, ECJ (‘SKF’), Beteiligungsgesellschaft Larentia + Minerva mbH & Co KG v Finanzamt Nordenham [2015] STC 2101 (‘Larentia’). The services must be for consideration, see below; or ●●

where it has a systematic involvement in the finances of the subsidiary, perhaps by making frequent loans at interest to and receiving frequent loans from the subsidiary: Empresa de Desenvolvimento Mineiro SGPS SA (EDM) v Fazenda Pública [2005] STC 65, ECJ (the EDM case). But the mere making of occasional loans to a subsidiary, even at interest, does not constitute a business: Floridienne SA v Belgian State [2000] STC 1044, ECJ. (If the loans are in the course of a business the interest on them will constitute exempt supplies, unless the borrower belongs outside the EU, in which case they will be outside the scope but with right of input VAT recovery, very similar to zero-rated); or

●●

in the writers’ view, where the subsidiary is owned or acquired as an extension to a business of the holding company’s own, or is a ‘trade investment’; for example, where the holding company has a business of its own (say, making widgets) and the subsidiary owns a property from which the holding company trades, or the subsidiary has regular commercial dealings with the holding company’s business and is owned for this reason; the subsidiary is then held for the purpose of benefiting that business. However, so far as the writers are aware, this has never been tested in any case law.

An (authorised) unit trust or similar entity is regarded as carrying on a business: Banque Bruxelles Lambert SA v Belgium [2004] STC 1643, ECJ.

The consideration point 3.7 The provision of goods or services is, for VAT, normally only a supply in the course of business if done for ‘consideration’. Consideration not only includes money but any form of payment, such as ledger adjustment on intercompany balances, payments in kind etc. Broadly what this means in the present context is that the provision by, say, a holding company of management services to a subsidiary will only be a supply in the course of business for VAT, and the holding company will only on that account be carrying on a business in relation to its shares in the subsidiary, if there is a contract – not necessarily a written contract, but it is better in practice if it is – in place between the holding company and the subsidiary for the provision of them. The contract must specify what charges will be made, or at least a formula or machinery for calculating them, and the charges must be considerably more than nominal (though they do not necessarily have to cover the holding company’s full costs). A mere vague intention to make charges is not enough: Norseman Gold plc v Revenue and Customs Commissioners [2016] STC 1276 (UT).

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Value added tax 3.9

Input VAT recovery 3.8 If a holding company does provide, say, taxable management services to its subsidiary for a consideration, the holding company’s input VAT on its day-to-day management costs will be recoverable by it on general principles, provided, of course, that it is registered for VAT. If, for example, it is making exempt supplies to its subsidiary or subsidiaries by the systematic making of loans, those will generally be exempt supplies and, if so, on general principles its input VAT will be irrecoverable. If it does both it will be partially exempt and the usual partial exemption rules will apply. However, the main VAT issue which arises in practice on the transactions explained by this book is the person’s input VAT recovery position in relation to any disposal or acquisition involved in the reorganisation or reconstruction; in particular, the recoverability of input VAT on the expenses that he incurs for the purpose of the transaction. Generally these will be legal, accountancy, bankers’, valuers’ and other professional fees. This is tackled transaction by transaction in the following chapters.

Does the fee attract VAT in the first place? Fees charged by intermediaries 3.9 When considering what a holding company’s or other person’s VAT position is on fees incurred, the easiest way of not having to bear input VAT on a fee is if the fee does not attract VAT in the first place, in other words is exempt. There is a class of fee which is exempt. The relevant provisions are in VATA 1994, Sch 9, Group 5, Item 5 and Notes (5)–(5B). This says that a fee is exempt if it is for ‘intermediary services’ by a person ‘acting in an intermediary capacity’. ‘Intermediary services’ are defined as: ●●

‘bringing together, with a view to the provision of financial services [meaning so far as we are concerned a transaction in shares or securities] – (a) persons who are or may be seeking to receive financial services, and (b) persons who provide financial services.’

A person is ‘acting in an intermediary capacity’: ●●

‘wherever he is acting as an intermediary … between (c)

a person who provides financial services, and

(d) a person who is or may be seeking to receive financial services.’ (Although a company which issues shares or securities does not make a supply of any kind for VAT, see 8.26 below, HMRC accept that when looking 91

3.9 Value added tax at whether the services of an alleged intermediary rendering services to that company are exempt, the company should be regarded as providing a financial service: VAT Notice 701/49/ at paragraph 9.4.) Article 135(1)(f) of VAT Directive 2006/112/EC says, more laconically, that ‘negotiation … in shares, … debentures and other securities’ is exempt. The French text’s word for ‘in’ is ‘portant sur’ (= concerning), which is clearer. The UK legislation expressly provides that services of market research, product design, advertising, promotional or similar services or the collection, collation and provision of information are never exempt when provided separately. Nor is the mere provision of advice. The exemption clearly covers the services of brokers (whether they call themselves brokers or not) – people who bring the parties together and have some involvement in fixing the terms (for example, an accountant providing corporate finance services). It is arguable that the fee of a mere introducer, in other words a person who brings the parties together but has no involvement in fixing the terms, is exempt under the provision, so long as he has given some careful thought as to whom to approach. A mere scatter-gun approach would be unlikely to qualify, see JCM Beheer BV v Staatssecretaris van Financiën [2008] STC 3360, ECJ dealing with the similar rule for insurance intermediaries; moreover it would probably fall foul of the exclusion for promotional or advertising services. The organisations whose fees may be exempt will generally be banks or other brokers. Lawyers, for example, though they are certainly involved in negotiating the detailed terms of the deal between the parties, almost always are only involved once the parties are together (or alternatively may provide general advice before the other party is found). Almost always their fees will be standard-rated. Sometimes an organisation renders services which are partly for exempt brokerage work and partly for standard-rated work, such as advice. Is the whole fee exempt, or is the whole fee standard-rated, or must the organisation apportion the fee? This takes us into the area of VAT law to do with composite and multiple supply. We can only scratch the surface of this here. A rule of thumb is that if the advice work is purely ancillary to the brokerage work the whole fee is exempt; in the unlikely event that the brokerage work is merely ancillary to the other work, the whole fee is standard-rated; in other cases the organisation should apportion and charge VAT on the standard-rated part of it. Where an organisation renders a purportedly standard-rated fee and the recipient considers that it should or might be exempt, he should challenge the organisation on the VAT status of the fee. Even if the recipient would be entitled to a refund of input VAT, VAT purportedly charged on what is 92

Value added tax 3.11 in law an exempt supply is not true input VAT and HMRC may deny input VAT recovery. In cases of doubt a recipient (unless he is confident that, if it is standard-rated, he will be entitled to a full refund of the input VAT) should also resist signing an engagement letter which has a clause along the lines of ‘if HMRC rule in writing that the supply is standard-rated, the recipient agrees to pay the VAT’. The problem with this is that it gives the organisation rendering the supply no incentive to argue vis-à-vis HMRC for exempt treatment: indeed the contrary, because making a taxable supply will improve its own input VAT recovery position. It is better that the contract states that any VAT will be borne by the parties 50:50, and the recipient should also stipulate for the right to be involved in making representations to HMRC. Where VAT is not mentioned in the contract, any charges are treated as VAT inclusive.

Costs from overseas: the reverse charge 3.10 Where a person who is carrying on a relevant business in the UK incurs fees for professional or other services from an overseas supplier, and the fee would have been standard-rated had the supplier been in the UK, the position is as follows. The supplier should not charge any local VAT (at least if he belongs in the EU). However, if the fee would have been standard-rated were there no foreign element, the UK client will be liable to UK output VAT on the cost under the reverse charge (or ‘tax shift’) rule: VATA 1994, s 8, Sch 4A, paras 1–9A. That VAT also counts as input VAT of his; whether or to what extent he can obtain a (simultaneous) refund of it as input VAT is governed by general principles, so if the input VAT relates to an exempt supply, the VAT is not recoverable. The reverse charge also counts towards a business’s taxable turnover, so if an unregistered business receives reverse charge services exceeding the current VAT registration threshold of £83,000, it will have to register for VAT and account for the reverse charge. If it relates to an exempt supply, this VAT will be irrecoverable. This rule does not apply to fees falling within the last section (intermediaries’ fees) because they are exempt – they would not be standard-rated were there no foreign element.

What is the effect of VAT grouping? 3.11 Under VATA 1994, ss 43–43D it is possible for one or more companies (and other bodies corporate like limited liability partnerships) which are directly or indirectly owned by one superior company, or by one individual, or by individuals in partnership, to elect to form a VAT group. The group is then treated as one person for VAT purposes and ‘supplies’ between members are 93

3.12 Value added tax disregarded and do not generate output VAT or input VAT. All supplies to group members from outsiders and all supplies by group members to outsiders are treated as received or made by the representative member of the VAT group. A company can be a member of a VAT group even if it, the company, does not itself carry on a business in its own right, thus a pure holding company can be a member of a VAT group: European Commission v UK [2013] STC 2076, ECJ, provided there is at least one company in the VAT group that does carry on a taxable business in its own right. It follows that if a holding company is carrying on a business in its own right (for example, providing management services to its subsidiaries), whether its input VAT on its day-to-day costs is recoverable by the group depends on the extent to which it is incurred for the purposes of the group’s supplies to third parties. This will depend on the facts, but often these costs will be part of the group’s general overheads of making its supplies to third parties and, if those supplies are all taxable, the input VAT on the holding company’s costs will be fully recoverable. See HMRC’s VAT Manual at VIT40100. Where a company is buying a subsidiary carrying on a taxable business and planning to group with it when it has bought it, and does so, does that improve its input VAT position on its incidental costs of purchase? This is explored at 8.26. In brief immediate grouping is best avoided. Where a company is disposing (to an outsider) of a subsidiary which is VAT grouped with it, and the holding company is providing, say, management services to it for a fee, the disposal of the shares will be a supply in the course of the group’s business, generally an exempt supply. It does not follow that the input VAT on the holding company’s sale expenses will necessarily be irrecoverable, because the SKF principle can apply (see 8.24): it can often be argued that the costs are not on the facts cost components of the disposal and are general overheads of the group’s business. If the holding company is not providing management services etc. to the subsidiary, it is very likely that the group’s supply of the shares will be outside the scope of VAT, but it can be argued in certain circumstances – where the reconstruction is being carried out to benefit the businesses of the group as a whole – that the SKF principle can apply to make the input VAT recoverable. But this is likely to meet stiff resistance from HMRC, see VAT Input Tax Manual at VIT40100.

Transfers of businesses as going concerns – ‘TOGCs’ 3.12 Often, in the course of a reconstruction, a company will transfer a business or part of a business that it is carrying on to another company. (The contrast with a transfer of shares is discussed below). Prima facie this is a standard-rated supply by the transferring company insofar as a straightforward sale of the assets would attract VAT – the fact that the consideration is not cash makes no difference. However, the United Kingdom and certain other 94

Value added tax 3.12 EU countries have a ‘transfer of business as a going concern’ (‘TOGC’) rule. Under this the transfer does not count as a supply of either goods or services and the transferor company is not liable to pay output VAT on the transfer. The UK TOGC rules are in VAT (Special Provisions) Order 1995, SI 1995/1268, art 5(1)–(3). The main requirements, if a transaction is to be a TOGC, are as follows: ●●

There must be a transfer of a business, or part of one, as distinct from a mere transfer of assets. If it is a transfer of part of a business the part must be capable of separate operation. The transferee must use the assets transferred for the purpose of a new or existing business of its own.

●●

If the transferor is registered for VAT, the transferee must either already be registered for VAT, become compulsorily registrable as a result of the transfer or (in HMRC’s view) be accepted by them before the transfer for voluntary registration. It is arguable that where the transferee is registered for VAT not in the UK but in another EU country which has a TOGC rule, that is enough, but it would be dangerous for a transferor to rely on that.

●●

When working out whether a TOGC transferee is compulsorily registrable, its compulsory registration turnover threshold is calculated as if it had already been carrying on the business for the past year. In other words, the distributing company’s taxable turnover is imputed to the transferee for the purpose (only) of ascertaining whether its registrability threshold is reached: VATA 1994, s 49(1), Sch 1, para 1(2).

●●

Where land or buildings are being transferred, and an actual sale of them would be standard-rated (because the transferor has opted to tax the property or because it is a freehold sale of a new commercial building), the TOGC rule does not apply to the transfer of that land and those buildings, and the transfer of them is an actual standard-rated sale, unless: $$

the transferee opts to tax the land or building (under VATA 1994, Sch 10), and notifies HMRC of the option, before the time of supply; and

$$

the transferee is able to, and does, make a declaration that SI 1995/1268, art 5(2B) will not apply to him – essentially, that its opting to tax will not be overridden by certain anti-avoidance provisions.

There is a good deal of case law on what counts as a transfer of a business or part of one, as distinct from a mere transfer of business assets, but those reconstructions described in this book involving a transfer of business assets will almost always amount to a transfer of a business or part of one. 95

3.13 Value added tax

Consequences of TOGC treatment 3.13 A transfer which is a TOGC does not count as a supply of goods or services by the distributing company. The transferor has no output VAT liability and the transferee incurs no input VAT. The transferee therefore (even if it would have been entitled to a refund of its input VAT on general principles) does not have the cash flow cost of having to pay it and obtain a refund of it. Any incidental input VAT which the transferor runs up in connection with the exercise counts as wholly attributable to the activities of the business being transferred, so that if, for example, it is a wholly taxable business, the VAT will be wholly recoverable by the transferor: Abbey National plc v Customs & Excise Commissioners [2001] STC 297, ECJ. The transferee’s position on any incidental input VAT run up by it is governed by general principles, so if it is acquiring a taxable business it will be able to recover all of it.

Transfer of company a TOGC? 3.14 Where the transfer is of shares in a subsidiary, the question has arisen as to whether that can be a TOGC. The short answer is that a transfer of shares on its own cannot be. If the transferor is carrying on a business of, for example, providing management services to the subsidiary AND the transferee takes over and runs that management business AND pays a separate consideration for that management business, the transfer of the management business will itself be a TOGC, but the transfer of the shares will not be part of it: Staatssecretaris van Financien v X BV [2013] STC 1893, ECJ. The transferor cannot, in the authors’ view, recover its input VAT on its incidental costs of the transfer of shares by invoking the Abbey National principle, but sometimes it will be able to recover by a different route: see 8.24. Where a transferring company has just transferred a business down into a subsidiary before demerging the subsidiary, the first transfer would normally be a TOGC. Incidental costs of the transferring company relating to that hive-down will be fully recoverable on the Abbey National principle, if the business being transferred is fully taxable.

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Chapter 4

EU legislation

SCOPE OF THIS CHAPTER 4.1 On 31 January 2020 at 11 pm (‘exit day’) the UK left the EU and, at the time of writing, the UK is now in a transitional period which will end at 11 pm on 31 December 2020 unless extended (‘IP completion day’). However, much of EU legislation will continue to apply during this period. Of fundamental importance, the European Union (Withdrawal) Act 2018 (‘EUWA’) was amended by the European Union (Withdrawal Agreement) Act 2020 (‘WAA’) which received Royal Assent on 23 January 2020. The WAA implemented the UK-EU Withdrawal Agreement into UK law. On exit day, the EUWA repealed the European Communities Act 1972 (‘ECA’) and the Withdrawal Agreement came into force, Part Four of which includes a requirement for most of EU law to continue to apply to the UK during the transitional period. In particular, it saves UK legislation that gave effect to EU Directives and Regulations until the end of the transitional period, after which time it can be subject to amendment or repeal in accordance with future enactments of the UK Parliament. At the time of printing, the authors are not aware of any plans to repeal or amend any UK tax legislation that is founded on EU law. However, Parliament has enacted amendments to company law to repeal the existing cross-border mergers and European company (‘Societas Europaea’, referred to as ‘SE’) legislation on IP completion day. Furthermore, the status of past and future European case law will become a question to be decided in the future. Subject to the important proviso that everything now must be regarded as subject to the outcome of the aforesaid negotiations on the UK’s future relationship with the EU, in the remainder of this chapter we will look at the current nature and status of EU legislation and its relationship with UK domestic law. We will then look at specific EU legislation that has had an impact on UK company law and UK tax law. In particular, we will be looking at the impact of the Consolidating Directive (EU) 2017/1132 (which consolidated the 3rd and 6th Company Law Directives1 and the Company Law Directive on cross-border mergers),2 the ‘Mergers Directive3 (also referred to as the European Mergers 97

4.2 EU legislation Tax Directive or ‘EMTD’), the European Companies Statute4 and the Cross-Border Conversion Directive (EU) 2019/2121.

1 Third Council Directive 78/855/EEC ([1978] OJ L295/36) concerning mergers of public limited liability companies and the Sixth Council Directive 82/891/ECC ([1982] OJ L378/47) concerning divisions of public limited liability companies. 2 Directive 2005/56/EC of the European Parliament and of the Council ([2005] OJ L310/1) on cross-border mergers of limited liability companies. 3 Council Directive 90/434/EEC ([1990] OJ L225/1) on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005). 4 Council Regulation (EC) No 2157/2001 ([2001] OJ L294/1) on the Statute for a European Company (SE).

INTRODUCTION TO EU LEGISLATION Purposive nature of EU legislation 4.2 The key to understanding EU legislation is to understand the intentions behind the EU itself. This is of course a huge subject and well outside the scope of this book. However, put very simply, a core purpose of the EU is to reduce barriers between countries that are members of the community. Originally, the barriers concerned were trade barriers, as in the six-member Coal and Steel Federation of 1951, and the later Common Market. Hence, we have the fundamental freedoms of the Treaty on the Functioning of the European Union (TFEU)1: freedom of establishment and free movement of capital, goods, services and people. Over the years, there has been a widening of the scope away from the merely commercial into other areas. Indeed, the perceived momentum towards fullscale political union, and the newer freedom to reside anywhere in the EU, has undoubtedly contributed towards the ultimate departure of the UK from the EU. EU legislation is, therefore, intended to promote an EU that is free of all barriers to cross-border commerce in particular. As a result, EU legislation is generally purposive and the purpose is invariably set out in the recitals at the beginning of the statute. So these recitals are often the most important part of the legislation as they tell us why it is there and we are required to interpret it in accordance with those stated purposes. For example, the TFEU itself says that the Member States are (inter alia): ●●

determined to lay the foundations of an ever closer union among the peoples of Europe; 98

EU legislation 4.4 ●●

resolved to ensure the economic and social progress of their countries by common action to eliminate the barriers which divide Europe;

●●

anxious to strengthen the unity of their economies and to ensure their harmonious development by reducing the differences existing between the various regions and the backwardness of the less favoured regions; and

●●

desiring to contribute, by means of a common commercial policy, to the progressive abolition of restrictions on international trade.

As a result, we must interpret the Treaty in the light of its aims, including those listed above. And the aims are set out in each piece of legislation so that they are clearly available to the judiciaries of each Member State as an aid to interpretation.

1 30 March 2010: http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:0047:0200:en:PDF

Relationship with domestic legislation 4.3 This is now governed by the EUWA, the WAA and the terms of the Withdrawal Agreement as outlined in the introduction to this chapter.

Hierarchy of EU legislation 4.4

There is a clear hierarchy of EU legislation.

Overriding all EU legislation are the fundamental freedoms of the EU. These are: ●●

freedom of movement for workers;

●●

freedom of establishment;

●●

freedom to provide services;

●●

free movement of goods;

●●

freedom of capital movements; and

●●

freedom of residence.

It is these fundamental freedoms that have generated the vast majority of tax cases in the European Court of Justice (ECJ) over the last 15 years or so. In essence, these cases have demonstrated that a number of UK domestic tax rules (and those of other Member States) contravene the fundamental freedoms by imposing, for example, tax charges that prevent or restrict free movement of workers, capital, goods or services or freedom of establishment. And the 99

4.4 EU legislation majority of those cases have been about whether domestic tax law in a given Member State restricts either the freedom of establishment of an entity or its freedom to move capital. The changes forced upon UK tax law by these cases are not the subject of this part of the book. However, readers will, of course, be familiar with the changes in FA 2000 relating to worldwide groups following ICI v Colmer1 and the changes on cross-border loss relief following the Marks & Spencer case.2 These are demonstrations of the way in which decisions of the ECJ are immediately binding on those to whom the decisions are addressed. That is, once the UK’s rules on group relief and loss relief were held to be incompatible with UK domestic tax legislation, those rules were unenforceable in an EU context and had to be amended to make them compatible with the EC Treaty. Similarly, in the Vodafone 2 case,3 the Court of Appeal decided that the UK’s rules on controlled foreign companies should ‘be interpreted in a way that conformed with Community law’. For our (simplified) purposes, we then need to consider Regulations and Directives. An EU Regulation is automatically part of the domestic law of any Member State and there is no requirement for the Member State to enact the Regulation into its own legal system. A Directive, however, had to be enacted into domestic legislation and it is therefore important that the Member State’s enactment is fully compliant with the purpose and explicit terms of the Directive. To some extent, it follows from the above that the two kinds of legislation have different roles. A regulation will cover areas of broad principle, while a Directive will be more specific about what the Member States must enact. For example, in the European Company Statute, the Regulation introduced a form of legal entity, the SE, which is to be recognised by all Member States as a public company incorporated in a specific Member State and sets out the formation and governance requirements. Consequential changes were needed, not to implement the legislation itself, but to facilitate its operation by, for example, introducing changes to the filings required at Companies House. The Directives associated with the Regulation lay down the specific rules that Member States are required to enact to make the SE concept work: Directive 2001/86/EC [2001] OJ L294/22 sets out the rules for worker participation in an SE and the amendments to the Mergers Directive gave detailed rules in respect of taxation, as we shall see later. In essence, since this level of implementation must take into account the national legal framework, there must be a margin for manoeuvre as to the form and means of implementation in each Member State. Looking at these differences, we now see the logic behind the hierarchy. To require all Member States to recognise an SE can be done merely by fiat. But the detailed rules to ensure that the wider purposes of the EU itself are met, 100

EU legislation 4.4 such as removing any tax barriers to setting up and running an SE, require legislation that will be specific to each Member State. So the Directive states what is required and the Member States must act (or enact) accordingly. So, now that we understand how EU legislation works, let us start to look at some of the specific legislation. There have been a number of developments since the last edition. On 20 July 2017, Directive (EU) 2017/1132 relating to certain aspects of company law (the ‘Consolidating Directive’) came into force. This simply acted to consolidate existing legislation by repealing and codifying a number of company law directives, of which the most relevant for the purposes of this book are: ●●

the Third Company Law Directive (codified) (2011/35/EU) – Concerning mergers of public limited liability companies;

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the Sixth Company Law Directive (82/891/EEC) – Division of public limited liability companies; and

●●

the Cross-Border Mergers Directive (2005/56/EC).

The Consolidating Directive provides that any references to the repealed directives shall be construed as references to the Consolidating Directive and these shall be read in accordance with the correlation table provided in Annex IV to the Consolidating Directive itself. The Consolidating Directive has been subsequently amended by Directive (EU) 2019/2121 as regards cross-border conversions, mergers and divisions (the ‘Cross-Border Conversions Directive’). For ease of reference, we have retained the summaries of the original directives and we cross-refer to the relevant articles4 of the Consolidating Directive as our readers are most likely to be familiar with these Directives. Where the substance of a recital has been retained in the Consolidating Directive we have provided the appropriate cross-reference. Where the recital has not been retained we have nonetheless kept the reference to it as, although the directives themselves have been repealed, the relevant legislative provisions to which the recitals refer survive in the Consolidating Directive so they still provide a valuable insight into the historical purpose of the legislation.

1 ICI v Colmer (C-264/96) and 72 TC 1. 2 Marks & Spencer v Halsey (C-446/03), judgment dated 13 December 2005. 3 Vodafone 2 v HMRC [2009] STC 1480. 4 With the exception of articles referring to implementation requirements for member states, as these will obviously not have been included in the Consolidating Directive.

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4.5 EU legislation

MERGERS OF PUBLIC LIMITED LIABILITY COMPANIES Articles 87 to 117 of the Consolidating Directive (formerly the Third Directive) 4.5 The Third Directive, properly known as the ‘Third Council Directive 78/855/EEC of 9 October 1978 concerning mergers of public limited liability companies’, was enacted in 1978 and required full implementation by Member States within three years (Art 32.1). So domestic company law of each Member State had to be fully compliant with the Directive by 1981. However, implementation was delayed until 1986 so that it could be implemented at the same time as the Sixth Company Law Directive (below).

Purpose of the Directive 4.6 As we have said, the first thing is to look at the recitals. There are several recitals to this Directive, but an appropriate selection should serve to illustrate the point. The first recital is, ‘[H]aving regard to the Treaty establishing the European Economic Community’, closely followed by reference to the ‘general programme for the abolition of restrictions on freedom of establishment’. So, the early recitals are firmly rooted in the EC Treaty itself and in the fundamental freedoms. The key recital specific to this Directive (retained in the Consolidating Directive at recital 49) states: ‘Whereas the protection of the interests of members and third parties requires that the laws of the Member States relating to mergers of public limited liability companies be coordinated and that provision for mergers should be made in the laws of all the Member States’. So this is the recital that tells us the specific purpose of this company law Directive. Article 2 of the Directive (now Article 88 of the Consolidating Directive) says: ‘The Member States shall, as regards companies governed by their national laws, make provision for rules governing merger by the acquisition of one or more companies by another and merger by the formation of a new company.’ The words in the recital, ‘that provision for mergers should be made in the laws of all the Member States’, can be read as meaning that Member States

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EU legislation 4.7 were required to amend domestic law so that mergers of public companies became permissible. But they can also be read as meaning something less, that where such transactions were already lawful in a Member State, that Member State was required to introduce legislation relating to the ‘protection of the interests of members and third parties’ for mergers of public companies. It is not clear which is the better interpretation of the Directive, although we incline to the latter (which is also more obviously in line with the Sixth Directive). But this was not relevant to the UK. As we shall see, the transactions described in the Directive were already lawful in the UK for all companies (ie not just public companies) and the UK implementation merely introduced the appropriate safeguards. Taking all of these together, we have a Directive to harmonise company law amongst Member States by ensuring that they all give appropriate protections to the stakeholders in mergers of public companies (and possibly require Member States to make mergers of public companies lawful, if this was not already the case), and this purpose is clearly part of the wider purpose of the EC Treaty itself and the fundamental freedom of establishment. The rest of the recitals then cover more specific issues, such as protection of shareholders, employees and creditors, and so on.

What is a merger? 4.7 The Directive defines two forms of merger, ‘merger by acquisition’ and ‘merger by formation of a new company’. Merger by acquisition is defined in Article 3(1) (now Article 89(1) of the Consolidating Directive) as: ‘the operation whereby one or more companies are wound up without going into liquidation and transfer to another all their assets and liabilities in exchange for the issue to the shareholders of the company or companies being acquired of shares in the acquiring company and a cash payment, if any, not exceeding 10% of the nominal value of the shares so issued or, where they have no nominal value, of their accounting par value.’ Such a transaction is illustrated in Figure 4.1.

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4.7 EU legislation Figure 4.1 Merger by acquisition

Merger by formation of a new company is defined in Article 4(1) (now Art 90(1) of the Consolidating Directive) as: ‘the operation whereby several companies are wound up without going into liquidation and transfer to a company that they set up all their assets and liabilities in exchange for the issue to their shareholders of shares in the new company and a cash payment, if any, not exceeding 10% of the nominal value of the shares so issued or, where they have no nominal value, of their accounting par value.’ Such a transaction is illustrated in Figure 4.2. Figure 4.2 Merger by formation of new company

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EU legislation 4.8 Figure 4.3 is also a form of merger by acquisition, whereby a company transfers all its assets to a subsidiary, which issues shares to the parent in consideration. Figure 4.3 Downstream merger

UK company law and mergers 4.8 As discussed above, we do not believe that the Third Directive was intended to introduce a new type of transaction into Member State law. It was only intended to introduce protections for stakeholders when public companies undertake the relevant transactions. The UK legal background will be discussed in detail in Chapter 19. However, in brief, we believe that UK company law permits mergers involving winding up without liquidation, for all companies. References in the Directive (and in the Sixth Directive, as we shall see) to companies being ‘wound up without going into liquidation’ are mirrored in similar terminology in UK company law, which refers to ‘dissolution without winding up’. This phrase was found in Companies Act 1948, s 208 and was replicated in Companies Act 1985, s 427(3)(d) and Companies Act 2006 (‘CA 2006’), s 900(2)(d). It seems reasonable to suppose that the phrases have similar effect. A dissolution without winding up implies a process where a company ceases to exist without a formal winding-up process, such as a dissolution, as does a winding up without a liquidation. If this is so, then UK company law has permitted mergers by dissolution without winding up for over 60 years. Furthermore, the Directive also states that, ‘A Member State’s laws may provide that merger [by acquisition or by formation of a new company] may also be effected where one or more of the companies being acquired is in liquidation, provided that this option is restricted to companies which have not yet begun to distribute their assets to their shareholders.’ (see Arts 3(2) and 4(2)). 105

4.9 EU legislation So, merger transactions using liquidations should also qualify for protection under the Directive, even though they are not strictly carried out by winding up without liquidation. There are other transactions that amount to mergers. Figure 4.4, for example, shows a merger transaction whereby a company transfers its assets to its parent before being dissolved. But the transferee company is therefore also the shareholder of the transferor company, so it cannot issue shares to itself. This doesn’t fit into the Third Directive definition of a merger. Since this would appear to be a lawful UK transaction, however, we already see a limitation on the effect of the Directive. Arguably, if this merger transaction were carried out by a public company, the Directive would not give shareholders and third parties any protection. Figure 4.4 Upstream merger

UK implementation of the Third Directive 4.9 As we have already made clear, the Directive is about introducing safeguards for shareholders and third parties when a UK public company merges. So the only new legislation needed was to introduce those safeguards. As noted above, implementation was delayed until 1986 so that it could be implemented at the same time as the Sixth Company Law Directive (below). The safeguards were enacted by the Companies (Mergers and Division) Regulations 1987, SI 1987/1991, which introduced the provisions now found in CA 2006, Pt 27. These contained specific further regulatory provisions for the divisions and mergers of public companies. No specific tax legislation was introduced in respect of these Directives, as it was not necessary. 106

EU legislation 4.11

DIVISIONS OF PUBLIC LIMITED LIABILITY COMPANIES Articles 135 to 160 of the Consolidating Directive (formerly the Sixth Directive) 4.10 The Sixth Directive is properly known as the ‘Sixth Council Directive 82/891/EEC of 17 December 1982 concerning divisions of public limited liability companies’. It was enacted in 1982 and required full implementation by Member States by 1 January 1986 (Art 26(1)). As mentioned above, this implementation was to be contemporaneous with that of the Third Company Law Directive.

Purpose of the Directive 4.11 As always, one must first look at the recitals. And the early recitals are, once again, firmly rooted in the EC Treaty itself and in the fundamental freedoms. The key recitals specific to this Directive then state: ‘Whereas Directive 78/855/EEC dealt only with mergers of public limited liability companies and certain operations treated as mergers; whereas, however, the Commission proposal also covered division operations; whereas the opinions of the European Parliament and of the Economic and Social Committee were in favour of the regulation of such operation; Whereas, because of the similarities which exist between merger and division operations, the risk of the guarantees given with regard to mergers by Directive 78/855/EEC being circumvented can be avoided only if provision is made for equivalent protection in the event of division; Whereas the protection of the interests of members and third parties requires that the laws of the Member States relating to divisions of public limited liability companies be coordinated where the Member States permit such operations’ (retained in the Consolidating Directive at recital 68). So these recitals tell us that this Directive is part of the same Commission proposal as the Third Directive, covering divisions as well as mergers, because of the similarities between the types of transaction involved. One point of difference, however, is that this Directive clearly only applies ‘where the Member States permit such operations’, so the Directive doesn’t require domestic legislation to be amended if these divisions are not permitted in domestic law. This is reinforced by Art 1 (now Art 135 of the Consolidating Directive), which makes it clear that the Directive only applies where the

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4.12 EU legislation division transactions described in the Directive are permitted by the domestic law of the Member State. Again, the purpose of the Directive is to ensure that there are adequate safeguards in place for the stakeholders in divisions of public companies. And this purpose is clearly part of the wider purpose of the EC Treaty itself and the fundamental freedom of establishment.

What is a division? 4.12 The Directive refers throughout to ‘divisions’ of companies. The word normally used in the context of UK transactions is ‘demergers’, although ‘demergers’ is used to cover a wider range of transactions than Sixth Directive divisions. In particular, the transaction referred to in other EU legislations as a ‘partial division’ would also be called a demerger in the UK. The Directive defines two forms of division: ‘division by acquisition’ and ‘division by formation of new companies’. Division by acquisition is defined in Art 2(1) (now Art 136(1) of the Consolidating Directive) as, ‘the operation whereby, after being wound up without going into liquidation, a company transfers to more than one company all its assets and liabilities in exchange for the allocation to the shareholders of the company being divided of shares in the companies receiving contributions as a result of the division (hereinafter referred to as ‘recipient companies’) and possibly a cash payment not exceeding 10 per cent of the nominal value of the shares allocated or, where they have no nominal value, of their accounting par value.’ Such a transaction is illustrated in Figure 4.5. Figure 4.5 Division by acquisition

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EU legislation 4.13 Division by formation of new companies is defined in Art 21(1) (now Art 155(1) of the Consolidating Directive) as: ‘the operation whereby, after being wound up without going into liquidation, a company transfers to more than one newly-formed company all its assets and liabilities in exchange for the allocation to the shareholders of the company being divided of shares in the recipient companies, and possibly a cash payment not exceeding 10% of the nominal value of the shares allocated or, where they have no nominal value, of their accounting par value.’ Such a transaction is almost identical to Figure 4.5 (above), but companies B and C will be new companies instead of existing companies. These transactions are more or less identical in mechanism, the only difference being that in a division by acquisition the transferee company is an existing (and perhaps active) company, while in a division by formation of new companies the transferee companies are new companies set up for the purpose of the division. As we shall see, they are also economically and mechanically almost identical to liquidation divisions or demergers, too.

UK company law and divisions 4.13 We have already noted that the Sixth Directive was not intended to introduce a new type of transaction into Member State law. It was only intended to introduce protections for stakeholders when public companies undertake the relevant transactions. UK company law only permits demergers involving winding up without liquidation if these transactions are schemes of reconstruction, as required by CA 2006, s 900(1)(a). In general terms, this means that the demerged or divided entities should have more or less the same shareholders, even though the activities of the companies have been separated. (See Chapter 15 for the company law on the meaning of ‘reconstruction’.) There are other methods of achieving a demerger involving a liquidation (rather than a winding up without liquidation) under Insolvency Act 1986, s 110 or a distribution in specie where the demerging company remains in existence. Demergers generally are discussed in detail in Chapter 21 onwards. The Sixth Directive also applies Arts 3(2) and 4(2) of the Third Directive to Sixth Directive divisions, so that a Member State’s laws may provide that division by acquisition or by formation of new companies may also be effected where the company being divided is in liquidation, provided that this option is restricted to companies which have not yet begun to distribute their assets to their shareholders (see Arts 2(2) and 21(2) of the Sixth Directive). So, divisions by liquidation may qualify for protection under the Directive, even though they are not strictly carried out by winding up without liquidation. 109

4.14 EU legislation

UK implementation of the Sixth Directive 4.14 As we have already noted, implementation was through the Companies (Mergers and Divisions) Regulations 1987 (SI 1987/1991), which introduced the provisions now found in CA 2006, Part 27. These contained specific further regulatory provisions for the mergers and divisions of public companies. No specific tax legislation was necessary.

The Cross-Border Conversion Directive 4.15 As referenced earlier in this chapter, on 1 January 2020, Directive (EU) 2019/2121, amending Directive (EU) 2017/1132 as regards cross-border conversions, mergers and divisions, entered into force. This amending directive makes the following changes in relation to divisions in the Consolidating Directive: (i)

It extends cross-border operations covered by the Consolidating Directive to include cross-border divisions as well as mergers. This applies to both divisions and partial divisions but only to divisions by formation of a new company. It then goes on to codify the requirements and consequences of a cross-border division.

(ii) It also adds a new type of division – ‘division by separation’ – whereby a company being divided transfers part of its assets and liabilities to one or more recipient companies, in exchange for the issue, to the company being divided, of securities or shares in the recipient (see Figure 4.6). Of course, to become applicable, this Directive would have to be implemented by domestic law. Member states have 36 months to pass the relevant legislation. At the time of writing, it is unclear whether any implementing legislation will be enacted in the UK to give effect to this Directive. Figure 4.6 Division by separation

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EU legislation 4.17

THE MERGERS DIRECTIVE 4.16 The next major piece of legislation from the EU is the so-called ‘Mergers Directive’, properly referred to as ‘Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States’. This was first enacted in 1990 and has been amended a number of times since, most recently in 2005.1 Calling it the ‘Mergers Directive’ has become a common shorthand but is also something of a misnomer, given the scope of the Directive. HMRC in the UK refer to it as the ‘European Mergers Tax Directive’ or EMTD, which is not much better, as it still only refers to mergers. So, in common with most commentators, we will continue to call it the Mergers Directive.

1 By Council Directive 2005/19/EC of 17 February 2005 ([2005] OJ L58/19) amending Directive 90/434/EEC ([1990] OJ L 225/1) on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States.

Purpose of the Mergers Directive 4.17 Clearly, the first clue to the Mergers Directive’s purpose is found in the title: it is intended to permit a ‘common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States.’ Once again, however, the recitals are also key to determining the scope of the Directive. The key recitals are: ‘Whereas mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States may be necessary in order to create within the Community conditions analogous to those of an internal market and in order thus to ensure the establishment and effective functioning of the common market; whereas such operations ought not to be hampered by restrictions, disadvantages or distortions arising in particular from the tax provisions of the Member States; whereas to that end it is necessary to introduce with respect to such operations tax rules which are neutral from the point of view of competition, in order to allow enterprises to adapt to the requirements of the common market, to increase their productivity and to improve their competitive strength at the international level; Whereas tax provisions disadvantage such operations, in comparison with those concerning companies of the same Member State; whereas it is necessary to remove such disadvantages’.

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4.18 EU legislation Essentially, therefore, the Mergers Directive is a piece of EU tax legislation (in contrast to the Third and Sixth Directives, which are company legislation) and it provides that neither companies nor their shareholders should suffer a tax barrier to performing such transactions across borders within the EU. So, for example, a cross-border merger between companies resident in different Member States should suffer no more tax than such a transaction carried out between companies both resident in the same Member State. What we also notice, however, is that the requirement that these tax barriers to certain transactions be removed is placed firmly into the wider context of the single market and the main EC Treaty. What these recitals also demonstrate is that the Mergers Directive is not intended to make such transactions tax-free. If a transaction carried out between two companies resident in the same Member State may carry a tax charge, the Directive only provides that a similar transaction carried out between companies resident in different Member States should not carry a greater tax charge.

Transactions referred to in the Directive 4.18

Article 1 states that:

‘Each Member State shall apply this Directive to mergers, divisions, [partial divisions1] transfers of assets and exchanges of shares in which companies from two or more Member States are involved.’ Article 2 then defines the various transactions, as set out below.

1 Words added by 2005 amendment to the Directive.

Merger 4.19

The Article 2 definition of a merger is:

‘… shall mean an operation whereby: ●●

one or more companies, on being dissolved without going into liquidation, transfer all their assets and liabilities to another existing company in exchange for the issue to their shareholders of securities representing the capital of that other company, and, if applicable, a cash payment not exceeding 10% of the nominal value, or, in the absence of a nominal value, of the accounting par value of those securities, 112

EU legislation 4.20 ●●

two or more companies, on being dissolved without going into liquidation, transfer all their assets and liabilities to a company that they form, in exchange for the issue to their shareholders of securities representing the capital of that new company, and, if applicable, a cash payment not exceeding 10% of the nominal value, or in the absence of a nominal value, of the accounting par value of those securities,

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a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to the company holding all the securities representing its capital.’

The first two of these are mergers by acquisition and mergers by formation of a new company, which we saw described in the Third Directive, and shown in Figures 4.1, 4.2 and 4.3. The final transaction is the upstream merger shown in Figure 4.4, to which we have already noted that the Third Directive does not apply. The words of the Mergers Directive regarding a company being ‘dissolved without going into liquidation’ are different from the Third and Sixth Company Law Directives, which refer to companies being ‘wound up without going into liquidation’ and also from UK company law, which talks about ‘dissolution, without winding up’. For the purposes of this book, however, we are assuming that they are effectively the same thing. It is also worth noting that the Mergers Directive applies to an issue of ‘securities’ to the holders of capital of the transferor company. So it can apply to issues of shares or of other securities. Again, this goes further than the Third Directive, which only refers to shares being issued. UK legislation has therefore enacted provisions referring to issues of shares or debentures, as we shall see.

Divisions and partial divisions 4.20 Article 2 originally only defined divisions. But the 2005 amendments added the concept of the ‘partial division’. Divisions are defined as: ‘an operation whereby a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to two or more existing or new companies, in exchange for the pro rata issue to its shareholders of securities representing the capital of the companies receiving the assets and liabilities, and, if applicable, a cash payment not exceeding 10% of the nominal value or, in the absence of a nominal value, of the accounting par value of those securities’. 113

4.21 EU legislation These are clearly the divisions by acquisition and divisions by formation of a new company referred to in the Sixth Directive. Once again, we note, however, that this Directive refers to the issue of securities, not just of shares. Partial division is defined as: ‘an operation whereby a company transfers, without being dissolved, one or more branches of activity, to one or more existing or new companies, leaving at least one branch of activity in the transferring company, in exchange for the pro-rata issue to its shareholders of securities representing the capital of the companies receiving the assets and liabilities, and, if applicable, a cash payment not exceeding 10% of the nominal value or, in the absence of a nominal value, of the accounting par value of those securities’. This looks much more like the non-liquidation demergers permitted under UK company law, whether by distribution in specie or by return of capital (Chapters 24 and 25, respectively).

Transfers of assets 4.21

A transfer of assets means:

‘an operation whereby a company transfers without being dissolved all or one or more branches of its activity to another company in exchange for the transfer of securities representing the capital of the company receiving the transfer’. This is effectively the incorporation of a branch in another Member State and required specific UK tax legislation (TCGA 1992, ss 140A–140D), as we shall see in Chapter 28. The 2005 amendments to the Directive also said that there were doubts as to the application of the original Directive to the conversion of branches into subsidiaries. To quote Recital 14 of the 2005 Directive, where: ‘… the assets connected to a permanent establishment and constituting a “branch of activity”, as defined in Article 2(i) of Directive 90/434/ EEC, are transferred to a newly set up company which will be a subsidiary of the transferring company and it should be made clear that this transaction, being the transfer of assets from a company of a Member State of a permanent establishment located in a different Member State to a company of the latter Member State, is covered by the Directive.’

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EU legislation 4.24

Exchanges of shares 4.22

An exchange of shares is:

‘an operation whereby a company acquires a holding in the capital of another company such that it obtains a majority of the voting rights in that company in exchange for the issue to the shareholders of the latter company, in exchange for their securities, of securities representing the capital of the former company, and, if applicable, a cash payment not exceeding 10% of the nominal value or, in the absence of a nominal value, of the accounting par value of the securities issued in exchange’. This refers to what we commonly call ‘share-for-share’ exchanges, covered in Chapter 8. As the definition refers to the acquisition of the majority of voting rights, a change to UK tax legislation, in TCGA 1992, s 135, was required.

Summary 4.23 To summarise, the Mergers Directive requires the UK to enact appropriate tax legislation to ensure that cross-border transactions of the kinds referred to are not tax disadvantaged in comparison to similar transactions involving only UK companies. However, it does specifically refer to whether such transactions must themselves be lawful in a cross-border context. So, for example, while a merger of UK companies was lawful, neither the Third Directive nor the Mergers Directive required a cross-border merger to be lawful. As we shall see, that required a specific Directive on cross-border mergers.

Implementation of the Directive in the UK 4.24 When the Directive was introduced in 1990, Member States were only required to implement those parts that related to transactions that were lawful in that Member State. So, as noted above, since a cross-border merger was not a lawful transaction in the UK, there was no requirement to enact any changes to UK tax law in this respect. Therefore, the partial implementation of the Directive into UK tax law in 1992 related only to the rules for transfers of assets, giving the branch incorporation rules in TCGA 1992, ss 140A–140D, and to the amendment of the rules for share-for-share exchanges.

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4.25 EU legislation The enactment of the rest of the Mergers Directive into UK tax law was through enabling legislation in FA 2007, s 110, which permitted appropriate new tax rules to be introduced by secondary legislation. These changes are in SI 2007/3186. Although these came into force on 29 November 2007, they were actually effective from 1 January 2007, except for the rules concerned with European Cooperative Societies, which were effective from 18 August 2006. In effect, the provisions were retroactive, although they had been adumbrated by extensive consultation for over a year before they were laid. These regulations were then amended by SI 2008/1579, which seems to consist primarily of corrections to errors in implementation in the earlier regulations!

CROSS-BORDER MERGERS Articles 160 and 118 to 134 of the Consolidating Directive (formerly the Cross-Border Mergers Directive) 4.25 This brings us neatly on to Directive 2005/56/EC of 26 October 2005 on cross-border mergers of limited liability companies. The crucial recital for this Directive is Recital (2), which says that: ‘This Directive facilitates the cross-border merger of limited liability companies as defined herein. The laws of the Member States are to allow the cross-border merger of a national limited liability company with a limited liability company from another Member State if the national law of the relevant Member States permits mergers between such types of company’ (retained in the Consolidating Directive at recital 55). This Directive is therefore another company law Directive, not a tax Directive. And what it requires is that, if a Member State permits domestic mergers of companies, then it must permit mergers of companies between Member States, ie cross-border mergers. As we saw earlier, the UK does permit domestic company mergers, so this Directive required UK legislation to permit crossborder mergers, too. This Directive was amended in 2019 by the Cross-Border Conversion Directive. Before we look at the implementation, however, we should look at the Sevic case.

THE SEVIC CASE 4.26 In the same year that the Cross-Border Mergers Directive was enacted, there was an important decision of the European Court of Justice (ECJ), in the 116

EU legislation 4.27 case of Sevic Systems AG (Case C-411/03). Sevic was a German company and it wished to merge with Security Vision Concept SA, a Luxembourg company. At the time, German company law permitted mergers of German companies by merger by acquisition and merger by formation of a new company, but it did not permit cross-border mergers. This merger was intended to comprise the merger by acquisition by Sevic of all the assets of Security Vision Concept, with Sevic therefore being the successor company. As this was a cross-border merger, the German authorities refused to register the merger and Sevic’s appeal was eventually transmitted to the ECJ for a view on whether this refusal constituted a breach of Sevic’s freedom of establishment under the main EC Treaty. The ECJ found that the refusal was indeed a restriction to the freedom of establishment and that there was no justification for that restriction. Even if there had been, a blanket restriction on all cross-border mergers could not be said to be proportionate. (Readers should be aware that some restrictions to the fundamental freedoms can be acceptable so long as there is justification for that restriction and that the restriction is proportionate.) So the result was that Sevic’s merger had to be recognised by the German authorities, on the basis of the EC Treaty itself and without the need for specific legislation directing Member States to permit cross-border mergers. This is an interesting result, which serves also to demonstrate how the overriding principles of the Treaty, towards the single market, can be effected in different ways to achieve the same end result. It also suggests that crossborder mergers of UK companies might well have been lawful even before the recent enactments relating to the Cross-Border Mergers Directive.

Implementation into UK law 4.27 Since this Directive relates to UK company law, UK company law was amended by regulations laid in late 2007 to permit cross-border mergers (the Companies (Cross-Border Mergers) Regulations 2007). The Directive has since been further amended by the Cross-Border Conversion Directive in 2019, which added a number of provisions aimed at further protecting members and creditors in relation to cross-border mergers. The more significant amendments include: ●●

extending the definition of cross-border mergers to include an operation whereby all the assets of one company are transferred to another without the issue of new shares, provided both companies are owned by the same person or the ownership structure of the group is unchanged after the transaction; 117

4.28 EU legislation ●●

an amendment to require the terms of a merger to include offers of cash compensation for members who do not vote for the transaction;

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a number of additional reporting requirements aimed at providing more information to members and creditors; and

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a requirement for there to be exit rights for members who do not vote for the merger or for those members who do not have voting rights. Furthermore, on exit, such members must be entitled to receive adequate cash compensation.

The new legislation is discussed in detail in Chapter 20. The UK Parliament has passed legislation revoking the Companies (Cross-Border Mergers) Regulations 2007 on IP completion day and it remains to be seen whether new cross-border merger legislation will be introduced at a later date.

THE EUROPEAN COMPANY STATUTE 4.28 The next element of our journey is the advent of the European company (‘Societas Europaea’, referred to as ‘SE’). The legislation governing the European company has two limbs. The first takes the form of a Regulation – Council Regulation No 2517/2001 of 8 October 2001 [2001] OJ L294/1 – which sets out the legal framework for SEs. The second takes the form of a Directive – Council Directive No 2001/86/EC [2001] OJ L294/22 – which supplements the Regulation in relation to employee involvement and amendments to the Mergers Directive for tax purposes. As a Regulation, the basic concept of the SE becomes effective in all Member States without the need to amend domestic legislation, but the Directive requires individual implementation in each Member State. In this case, the Regulation became effective on 8 October 2004, so from that date UK company legislation had to recognise the existence of this new type of corporate entity.

European cooperatives 4.29 The European Company Statute includes the legislation relating to European Cooperative Societies, Council Regulation (EC) No 1435/2003 [2003] OJ L207/1 on the Statute for a European Cooperative Society (SCE). The only UK entities to which the legislation applies appears to be Industrial and Provident Societies. These are entities formed under the Industrial and Provident Societies Act 1965. SCEs can be formed by mergers of cooperatives from different Member States (Art 2(1) of the Regulation) and these mergers are covered in the amended 118

EU legislation 4.30 UK legislation at TCGA 1992, ss 140E–140G. We will not be looking at SCEs (or Industrial and Provident Societies) in any detail but we will cover the relevant legislation in Chapter 20.

Relevance to UK legislation on mergers 4.30 There are a number of elements to this. Firstly, the Regulation defines a number of ways by which an SE can be formed, one of which is by merger (Art 2(1)). This is subsequently defined further by Art 17, which states that: ‘1.

An SE may be formed by means of a merger in accordance with Article 2(1).

2.

Such a merger may be carried out in accordance with: (a)

the procedure for merger by acquisition laid down in Article 3(1) of the third Council Directive (78/855/EEC) of 9 October 1978 based on Article 54(3)(g) of the Treaty concerning mergers of public limited-liability companies or

(b) the procedure for merger by the formation of a new company laid down in Article 4(1) of the said Directive.’ In the case of a merger by acquisition, the acquiring company shall take the form of an SE when the merger takes place. In the case of a merger by the formation of a new company, the SE shall be the newly formed company.’ This company law Regulation pre-dated the Cross-Border Mergers Directive and therefore required UK legislation to recognise, for the first time, the validity of a cross-border merger. Also, we see that Art 17(2)(a) is referring to a merger by acquisition, as described in the Third Directive. And Art 17(2)(b) refers to a merger by formation of a new company. So we have direct feedback from the European Company Statute into the Third Directive, ensuring that the formation of an SE grants shareholders and third parties the protections due on mergers of public companies. The European Company Statute is brought within the ambit of the Mergers Directive, by the 2005 amendments to that Directive. Since SEs are now being covered by the Mergers Directive, this means that the formation of SEs must not be tax disadvantaged in comparison with ‘mergers, divisions, partial divisions and exchanges of shares’ between UK domestic companies or between UK companies and corporate entities of other Member States. As an aside, it is interesting to note that the Regulation does not seem to permit the formation of an SE by an upstream merger of a subsidiary into its parent, 119

4.31 EU legislation even though the revised Mergers Directive does bring such a transaction within the definition of a merger. The UK tax legislation dealing with the formation of SEs, enacted in Finance Act 2005 and amended via FA 2007, s 110, is covered in Chapter 20.

SOCIETAS EUROPAEA 4.31 The overall use of the Societas Europaea within the EEA (as well as in the UK) has been limited but with some significant and high-profile exceptions.

Purpose of the European Company Statute 4.32 The intention of the Regulation was to provide for the formation and existence of a corporate entity which is not specific to any Member State or to the law of any Member State. Instead, it is a pan-European entity incorporated under EU law and, hypothetically, subject to EU law. In reality, an SE can only be formed by registration in a Member State and, although it is subject to some common rules set out in the SE Regulation, where these are silent the local corporate laws under which it is established will apply, as well as the national law of the Member State in which it has its registered office and the national laws that will apply where it operates. This means governance of SEs will vary between Member States. The 29 preliminary recitals make interesting reading. Recital 3, for example, refers to the ‘psychological difficulties’ of restructuring and co-operation involving companies from different Member States! Probably most important, however, is Recital 7, which reads as follows: ‘The provisions of such a Regulation will permit the creation and management of companies with a European dimension, free from the obstacles arising from the disparity and the limited territorial application of national company law’. So the main point is that we have an overriding European statute allowing the formation of a European corporate entity which has the status of a public limited liability company. Does this entity have genuine pan-European status being governed by European company law? The answer, of course, is ‘no’. First, Recital 20 specifically states that the Regulation does not cover areas of law such as taxation, competition, intellectual property or insolvency. Perhaps the more obvious fudge, however, is in Recital 9. This refers to ‘work on the approximation of national company 120

EU legislation 4.33 law’ having ‘made substantial progress’. It goes on to say that ‘where the functioning of an SE does not need uniform community rules reference may be made to the law governing public limited liability companies in the Member State where it has its registered office’, so that for the moment at least, an SE is a pan-European entity governed for almost every purpose by the legislation applicable to a public limited liability company in the Member State in which the registered office is situated.

Comparison with UK public companies 4.33 This is not to say that, for example, an SE with its registered office in the UK is in every way identical to a UK plc. There are differences, the main one probably being the requirement for employee involvement in the administration of the company, although there is no requirement to introduce involvement where none existed before among employees of companies participating in the formation of the SE. This is achieved by the Regulation itself and by a Directive supplementing the Regulation (Council Directive 2001/86/EC). This explains that this requirement is ‘to promote the social objectives of the Community’ (Recital 3). There are other differences between a UK plc and an SE as shown in the table below: UK plc Directors Minimum two directors, no maximum period of service Company Secretary Required Employee Not required involvement

Location of registered office

Cannot transfer registration to another EEA country

Share capital

Any currency permitted and minimum of £50,000 paid up to a quarter Does not need to be in country of registration

Head office

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SE Minimum two directors, six years maximum period of service Not required A Special Negotiating Body is required to carry out negotiations for employee involvement in the SE Can transfer between Member States with continuity of legal personality EUR 120,000 or the local currency of incorporation if outside the Eurozone Must be in country of registration and sometimes in the place of registration

4.34 EU legislation In short, the SE is the equivalent of a public limited liability company and is incorporated in a specific Member State rather the EU. It has share capital which it can issue to shareholders or trade on a stock exchange and it has the status of any other body corporate. Probably the main difference between an SE and a local public limited liability company is the ability to transfer the registered office between Member States and even this ability is constrained by the fact that neither the Mergers Directive nor the European Company Statute requires that this be tax-free. What this means is that the company might be able to move its registered office to another Member State under company law, but local tax rules may still impose a tax charge for doing so. In the UK, for example, there is a charge on company migration under TCGA 1992, s 185 and specific provisions relating to the residence of SEs in CTA 2009, s 16. The EU Anti-Tax Avoidance Directive (Council Directive (EU) 2016/1164) also imposes exit taxes where ‘a taxpayer transfers its tax residence to another Member State or to a third country, except for those assets which remain effectively connected with a permanent establishment in the first Member State’ under Article 5(1)(c). Of course, an exit charge on migration from a Member State (in the UK) might appear contrary to the fundamental freedoms, such as the free movement of capital and possibly freedom of establishment too. The European Commission clearly thinks so in certain circumstances, as in March 2012 the Commission requested that the UK change its corporate exit charge rules (TCGA 1992, s 185). In a reasoned opinion (the second stage of the enforcement process), the Commission said that the UK had ‘failed to fulfil its obligations’ to the EU by making it more expensive to transfer a company’s place of effective management to another Member State than to another location in the UK. The Gallaher case (see Chapter 1) is another example where UK tax legislation was found to have some shortcomings vis-à-vis EU law. Otherwise, in the absence of a pan-European body of company law, the SE is liable to the body of legislation covering public companies and their activities in the Member State in which it is resident by virtue of the location of its registered office. This includes, of course, tax legislation, which is likely to be the area of major interest to most readers.

Formation of an SE 4.34 The European Company Regulation prescribes five ways in which an SE can be formed: ●●

by merger of two or more existing public limited liability companies resident in different Member States (Art 2(1)). This is discussed in more detail above; 122

EU legislation 4.35 ●●

under Art 2(2), a holding SE can be ‘promoted’ by two or more companies, not necessarily public limited liability companies. Either the promoting companies themselves or their subsidiaries or branches must be in different Member States, so there must be a cross-border element for the formation of the holding SE. Article 3 of the Regulation suggests that the transaction involves the formation of the SE as a holding company of the promoting companies with the shareholders of those companies donating their shares to the SE for the return of an issue of shares by the SE to those shareholders;

●●

Article 2(3) allows the formation of a subsidiary SE by two or more ‘legal bodies’ resident in different Member States (or having subsidiaries or branches in different Member States). Note the reference to ‘legal bodies’ rather than just companies. This would permit the formation of a subsidiary SE by, for example, a UK limited liability partnership or possibly by a Scottish partnership, but not an English partnership;

●●

Article 2(4) permits an existing public limited liability company in a Member State to transform itself into an SE. Again, however, there is a requirement for a cross-border element to the transaction; the originating company must have had a subsidiary (not just a branch) in another Member State for at least two years;

●●

Article 3(2) permits an existing SE to form a subsidiary SE.

As discussed, there is nothing in existing EU legislation to force a change of UK company law in terms of mergers of companies, whether domestically or cross-border. Furthermore, much of existing UK tax law would probably have applied to the formation of SEs without the need for further change. Nevertheless, a number of changes, some necessary, many less obviously so, were made by F(No 2)A 2005.

Commercial considerations 4.35 We have now looked at the legal background to an SE and the ways in which they can be formed. Later in this chapter, we will look at the way UK tax law complies with appropriate EU legislation, but why would a company want to form an SE? This type of company seems to have very few advantages over a public limited liability company incorporated in a specific Member State. The overall number of SE incorporations has therefore been relatively low. On 19 November 2010, the European Commission published a report to the European Parliament and Council on the use of the SE Regulation. At that point, only 595 SEs had been formed within the EEA. More recently, however, SEs have been used in the context of Brexit reorganisations, often as part of a broader arrangement which includes a cross-border merger or transfer of assets. 123

4.36 EU legislation Public comment that has been made by companies considering the formation of an SE has concentrated on the ability to move the registered office from one Member State to another without winding up or re-incorporating. The European Company Statute requires, however, that the registered office be in the same Member State as the head office, so to move the registered office would also involve moving the head office. Given that transfers of assets from one Member State to another are not intended to be tax-free, as noted above, it is not clear that this necessarily grants a benefit. However, if the assets associated with the head office are relatively minor, then a transfer of the registered office can be advantageous in certain circumstances. For example, German corporate law requires both an executive board and a supervisory board, the latter having equal numbers of non-executive directors and employees. The requirements for employee representation on an SE are somewhat less onerous. So immediately one can see potential commercial advantages to being able to move to another Member State and take advantage of these less onerous requirements. Another reason might be that a company has expanded outside its home country so much that only a very small number of employees remain in the original home country. Again, one might see very good reasons for moving to a Member State where the company has more material presence or, indeed, where a listing on the local stock exchange might be seen as more prestigious than in the home state. Some groups have also adopted the SE as part of a corporate simplification strategy. Finally, there is the matter of perception or image. A company headed up by an SE might be seen as having greater gravitas as a European group, rather than being seen as a German, UK or Hungarian group, for example.

Residence of SEs and SCEs 4.36 UK tax legislation treats a company as tax resident if it is incorporated in the UK, by Corporation Tax Act 2009 (‘CTA 2009’), s 14. Clearly this provision cannot be applicable to an SE, as an SE cannot be incorporated in the UK, being an EU entity. However, at the moment an SE is subject to the laws of the Member State where it is resident, defined as being the Member State where its registered office is. Therefore, a definition for the residence of an SE was required for UK tax purposes, which is found at CTA 2009, s 16. The residence of an SCE is similarly determined by CTA 2009, s 17. CTA 2009, s 16 broadly provides that an SE or SCE that has its registered office in the UK, or that transfers its registered office to the UK, will be treated as

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EU legislation 4.37 resident in the UK for all tax purposes. This applies even if the company has dual residence in another jurisdiction, too. If the company subsequently transfers its registered office outside the UK, it does not automatically cease to be UK tax resident, by virtue of this provision. However, if the operation of any double tax treaty requires an SE that has moved its registered office out of the UK to be treated as resident in another Member State, CTA 2009, s 18 provides that the company is to be treated as resident in that Member State, and not in the UK. In practice, in the experience of the authors the ability of an SE to change the location of its registered office has caused it to be used as a vehicle by certain internal groups that have wanted the flexibility to be able to migrate an entity that has public limited company status, although to date it has only be in a handful of cases where the circumstances have existed to make this sufficiently attractive to make use of legislation which still is unfamiliar to most practitioners. However, one of the most immediate consequences of the Brexit vote had been a renewal of interest in the use of an SE, as the conversion of a public limited company into an SE to facilitate future migration may be a sensible ‘no regrets’ immediate action that could then be exploited or reversed in the future, depending on the outcome of the Brexit negotiations.

Compliance provisions: continuity for transitional purposes 4.37 One of the attractions of the SE is the ability to change the registered office and hence the Member State of residence. FA 1998, Sch 18, paras 87A and 87B make provision regarding tax compliance for SEs changing residence. This provision ensures that it is still possible to charge tax on a UK resident company up to the time when it either participates in a merger to form an SE outside the UK or, having merged into an SE, transfers its registered office to another Member State. It does this by ensuring that the provisions in FA 1998, Sch 18 relating to tax returns, assessments and so on, can still be applied to companies after they have merged into an SE or transferred their registered offices outside the UK, in relation to liabilities accruing and matters arising before the date of the merger or transfer. If a UK company has merged into a non-UK resident SE, FA 1998, Sch 18 continues to apply in respect of liabilities accruing and matters arising before the merger as if the company were still resident in the UK and, if the UK company has ceased to exist in the merger, as if the SE were that company (FA 1998, Sch 18, para 87A). So either the remaining UK company or the SE can be required to make returns, etc in respect of pre-merger periods.

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4.38 EU legislation Similarly, if an SE has transferred its registered office from the UK and ceased to be UK resident, for the purposes of FA 1998, Sch 18 in respect of liabilities and matters arising prior to that time, the SE is treated as still being resident in the UK (FA 1998, Sch 18, para 87B). Despite extensive changes to the tax legislation in 2007 referring to SCEs, there do not appear to be any similar provisions for SCEs relating to a change of registered office. The continued use of the SE in the UK will be very limited. The European Public Limited Liability Company (Amendment etc) (EU Exit) Regulations 2018 will come into force on the IP completion day. This aims to ensure that UK registered SEs maintain after that date their legal personality and a legal framework within which to operate, but after that date it will no longer be possible to transfer an SE into or out of the UK or to register a new SE in the UK. Any existing SEs still registered in the UK will be automatically converted into a ‘UK Societas’, a new type of corporate entity that maintains most of the rights held by an SE and enables it to convert into a UK public limited company.

Cross-border conversions 4.38 As previously stated, on 1 January 2020 a new Directive came into force that amends certain provisions in the Consolidating Directive. One such amendment is to introduce ‘cross-border conversions’, whereby a limited liability company formed under the laws of one Member State can convert its legal form into that of another Member State and transfer its registered office to that state without going into liquidation or there being any other cessation of legal personality. On transfer the company will become subject to laws of the destination Member State. This effectively means that, under this Directive, the ability of a company to transfer its seat from one Member State will apply to limited liability corporate entities generally. Whilst several EEA jurisdictions do permit transfers of seat on an equivalence basis, this Directive will permit transfers of seat generally across the EEA, thereby reducing the need for an SE for this purpose. Since Member States have 36 months to implement this Directive into domestic law, at the time of writing we feel it is unlikely that the UK will do so during the transitional period.

WHAT DOES THE FUTURE HOLD? 4.39 There are a number of strands of EU developments which might be seen as giving pointers to a potential future for the SE within the EU. However, since the UK has left the EU, these may well be irrelevant for UK domestic purposes. That said, some understanding of these matters will remain relevant 126

EU legislation 4.39 to tax advisers, as our clients will no doubt continue operating within the EU in some form or another. The UK may also decide to align certain policy decisions with the EU. Proposals for a common consolidated corporate tax base have been revived (if they ever went away) in recent years. The theory behind this is partly a finding that the main driver of effective tax rates in each Member State is, in fact, the headline corporate tax rate and that the different ways in which the figure of taxable profit (as opposed to accounting profit) is reached in each Member State have a relatively low impact on effective tax rates. Therefore, it might be thought that Member States will be less likely to demur from harmonisation of the tax base than they are from complete tax harmonisation. It is, however, worth noting that the UK has consistently opposed such a proposal and has ‘philosophical objections’ to any form of tax harmonisation. There are also moves towards greater harmonisation of corporate governance throughout the EU as evidenced, for example, by the 2003 EC Action Plan and the DTI’s 2005 paper ‘Promoting Competitiveness – the UK approach to EU company law and corporate governance’. Again, while the UK may not be bound by future EU decisions, it might choose to implement them, or be required to do so as part of the terms of trading with the bloc. Finally, of course, there is the long standing EU desire for complete tax and company law harmonisation across all Member States, with discussions rumbling on for most of the last 30 years in both cases. It is possible that the UK leaving the EU may cause these movements towards greater harmonisation to be accelerated. Partly this may follow from the removal of the UK as a source of opposition, but also because the voting rules for the adoption of any such change may be modified by the introduction of qualified majority voting, which may facilitate the achievement of the necessary agreement across Member States for such developments to occur. Of course, the UK’s role in such developments is likely to be that of an observer and, at present, the revocation of the rules on cross-border mergers1 and the SE2 will reduce the corporate options for UK companies wishing to carry out cross-border restructurings. It remains to be seen whether this changes in the future in the context of the UK’s new role outside the EU.

1 Companies Limited Liability Partnerships and Partnerships (Amendment etc) (EU Exit) Regulations 2019 (SI 2019/348), reg 5 will revoke the Companies (Cross-Border Mergers) Regulations 2007 (SI 2007/2974) and associated legislation at the end of the transition period (currently being 31 December 2020 at 11pm). 2 The European Public Limited-Liability Company (Amendment etc) (EU Exit) Regulations 2018 (SI 2018/1298), which will also come into force at the end of the transition period, contain provisions for the conversion of UK-registered SEs to a UK Societas.

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4.40 EU legislation

CONCLUSION 4.40 Previous editions of this book have speculated about the possible future direction of further harmonisation of EU tax and corporate law. With Brexit, it must be assumed that the UK will play no further part in such harmonisation in the future. Furthermore, the impact of European legislation on UK tax law will be under question, to be determined by the terms under which the UK leaves the EU.

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Part 2

Reorganisations

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Chapter 5

Introduction to reorganisations

INTRODUCTION 5.1 This Part of the book is concerned with the basic legislation covering ‘reorganisations’. In particular, we will be looking at the tax position of companies ‘reorganising’ their capital base, whether share capital or loan capital. In Part 3, we will look at certain transactions that are treated as reorganisations for tax purposes and the reliefs available for these transactions. We will also look at the interaction of the reorganisation provisions with other parts of the tax legislation. First, we should look at what is meant by the word ‘reorganisation’ for tax purposes.

MEANING OF ‘REORGANISATION’ – THE PLAIN ENGLISH APPROACH 5.2 The first thing to note is that readers will search in vain for a definition of the word ‘reorganisation’ in the tax legislation. The best we get is that TCGA 1992, s 126 tells us that, for the purposes of the specific legislation – TCGA 1992, ss 127–131 – ‘… “reorganisation” means a reorganisation or reduction of a company’s share capital …’. So we actually have nothing to tell us what is meant by the word ‘reorganisation’, apart from the fact that it probably has something to do with a company’s share capital. Let us turn to the plain English approach. The Oxford English Dictionary1 tells us that a ‘reorganisation’ is ‘the action or process of reorganising’ or ‘an instance of fresh organisation’. The latter definition seems most promising in the context of company legislation as we are clearly talking about the way a company organises itself in terms of its capital base. More helpful still is the definition of ‘reorganise’, which is given as ‘organise again or differently’, ie a reorganisation for the purposes of a company’s share capital can be taken as the company organising its share capital differently. 131

5.2 Introduction to reorganisations We should also look at company law. Although there is no direct nexus between company law and tax law as it applies to companies, it is clear that tax legislation has been informed by company law and, indeed, that the reverse is true and that some company law has been informed by tax legislation2. As we shall see in Chapter 15, in the case of Hooper v Western Counties and South Wales Telephone Co Ltd [1892] 68 LT 78, Chitty LJ found the words ‘reorganisation’ and ‘reconstruction’ to be alternative terms, ie meaning the same thing. This is clearly not the case for tax purposes where reorganisations and reconstructions are different types of transaction, even though they may be dealt with in the same way for many tax purposes. In the case of Re Palace Hotel [1912] 2 Ch 438, we find that CA 1907, s 39, re-enacted as Companies (Consolidation) Act 1908 (‘CCA 1908’), s 45, referred to a company being able ‘to reorganise its share capital’ whether by ‘the consolidation of shares of different classes’ or by ‘the division of its shares into shares of different classes’3. This is a very limited provision and in the case from which these provisions were quoted, the transactions concerned involved reducing the nominal value of two different classes of share capital and reducing the dividend rights on one of them. Since these were neither consolidations nor divisions into different classes, CCA 1908, s 45 was held not to apply, although both transactions are capable of being reorganisations for tax purposes under modern legislation. This case also referred to CCA 1908, s 1204 which was the provision that authorised the transactions that were proposed (and which did not fall into CCA 1908, s 45). In the later case of Re Schweppes Ltd [1914] 1 Ch 322, we are told that CCA 1908, s 120 is the provision that permitted the amendment of the memorandum of a company, including transactions to which CCA 1908, s 45 might also apply. In essence, resolutions under CCA 1908, s 45 had more stringent voting requirements than did CCA 1908, s 120. Since the ‘reorganisation’ in the Palace Hotel case did not fall within CCA 1908, s 45, but was within CCA 1908, s 120, the resolution under the less stringent voting requirements was held to be valid. However, none of this assists us with a definition of ‘reorganisation’. Overall, therefore, there is not much help from company jurisprudence and we are left with the dictionary definition that a reorganisation can be taken as the company organising its share capital differently.

1 4th edn, 1993. 2 For example, the distributions legislation. The word ‘distribution’ did not appear in company legislation until the CA 1985, although it had been in tax legislation since 1965 when corporation tax was introduced. 3 In the judgment of Swinfen Eady J. 4 This appears to be the direct forerunner of CA 1985, s 425, now CA 2006, s 899.

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Introduction to reorganisations 5.3

EARLY TAX LEGISLATION 5.3 As we know, the earliest legislation charging tax on gains was in the short-term gains legislation of FA 1962 charging short-term gains to income tax under a new Case VII of Schedule D. The original legislation relating to reorganisations, FA 1962, Sch 9, para 10, read as follows: ‘(1) This paragraph shall apply in relation to any reorganisation or reduction of a company’s share capital; and for the purposes of this paragraph – (a) references to a reorganisation of a company’s share capital include – (i)

any case where persons are, whether for payment or not, allotted shares in or debentures of the company in respect of and in proportion to (or as nearly as may be in proportion to) their holdings of shares in the company or of any class of shares in the company; and

(ii) any case where there are more than one class of share and the rights attached to shares of any class are altered; and (b) “original shares” means shares held before and concerned in the reorganisation or reduction of capital, and ‘new holding’ means, in relation to any original shares, the shares in and debentures of the company which as a result of the reorganisation or reduction of capital represent the original shares (including such, if any, of the original shares as remain). (2) Subject to the following sub-paragraphs, a reorganisation or reduction of a company’s share capital shall not be treated as involving any disposal of the original shares or any acquisition of the new holding or any part of it, but the original shares and the new holding shall be treated as the same asset acquired as the original shares were acquired.’ This was re-enacted in virtually identical form in FA 1965, Sch 7 as part of the original capital gains tax legislation and it is also clearly recognisable as being the precursor to the current legislation, albeit somewhat reordered – FA 1965, Sch 7, para 10(1)(a) has become TCGA 1992, s 126(2); FA 1965, Sch 7, para 10(2) has become TCGA 1992, s 126(1); and FA 1965, Sch 7, para 10(3) has become TCGA 1992, s 127. From its inception, the tax legislation clearly went beyond mere organisation and reorganisation of a company’s share capital. For tax purposes, the concept of a reorganisation applied to an increase in capital, as well as to the conversion of share capital into debentures and to conversions of securities1 (FA 1962, Sch 9, para 11), either into other securities or into share capital. Furthermore,

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5.4 Introduction to reorganisations the legislation clearly recognised that a reorganisation could occur in respect of individual classes of shares, as well as to the share capital taken as a whole. For the purposes of this introduction, however, we will restrict ourselves to discussing the unexpanded meaning of the word ‘reorganisation’.

1 The difference, if any, between debentures and securities is a complex area. For the purposes of this book, the terms are largely treated as synonymous. For a more detailed treatment of the meaning of ‘security’, see Chapter 7.

THE MEANING OF ‘REORGANISATION’ – CASE LAW 5.4 We still do not have anything in the legislation that serves as a definition of what is actually meant by the word ‘reorganisation’ for tax purposes. Parliament appears to have decided that this could be left to common usage1; what would the man on the Clapham omnibus consider was a reorganisation? This presumably was assumed to make sense to legislators at the time, although the matter has troubled the courts occasionally since then. The most notable instance was the 1985 case of Dunstan v Young, Austen & Young Ltd 61 TC 448; see Figure 5.1. In 1977, the taxpayer company (‘YAY’) acquired for £16,100 all the 1,000 issued shares of £1 each in a company, Jones Refrigeration Ltd (‘Jones’). When, shortly afterwards, YAY joined the Trafalgar House group, one share in Jones was transferred to another group company (‘THIGS’) to hold as nominee for YAY. Subsequently, Jones made severe losses and owed over £200,000 to YAY and other members of the group and it was decided that Jones should be sold. In order to achieve this, the debt was capitalised by YAY subscribing for 200,000 new £1 shares in Jones which was used to pay off its debt to YAY. On the same day, Jones was sold for £38,000. The question for the court was whether the capitalisation of the debt of £200,000 amounted to a reorganisation within the meaning of FA 1965, Sch 7, para 4, the forerunner of TCGA 1992, s 127. If it did, then the additional consideration given when subscribing for the new shares, £200,000, gave a total base cost for the shareholding of £216,100 and there was a capital loss of £178,100 (being the base cost less the £38,000 received). The Revenue argued that the issue of new shares did not amount to a reorganisation as defined by paragraph 4, but was an issue of shares by way of a bargain other than at arm’s length (then FA 1965, s 22(4), currently TCGA 1992, s 17(1)) so that the base cost for the new shares was nil, as the company was heavily in debt, and there should be no capital loss. (There is an obvious argument that the Inland Revenue should have allowed £38,000 new base cost, on the basis that the company was sold for this sum on the same day as the recapitalisation. However, no such argument was made in front of the courts, according to the case reports.) 134

Introduction to reorganisations 5.4 Figure 5.1 Dunstan v Young, Austen & Young Ltd

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5.4 Introduction to reorganisations The legislation in FA 1965, Sch 7, para 4 was almost identical to its current form in TCGA 1992, s 126. Specifically, FA 1965, Sch 7, para 4(1)(a) read: ‘References to a reorganisation of a company’s share capital include … any case where persons are, whether for payment or not, allotted shares in or debentures of the company in respect of and in proportion to (or as nearly as may be in proportion to) their holdings of shares in the company or of any class of shares in the company …’ It was agreed that a conventional rights issue plainly fell within this definition. However, the capitalisation had not been carried out by way of a rights issue, which is why the Revenue was able to argue that there had not been a reorganisation within FA 1965, Sch 7, para 4(1)(a). The company’s argument was that the use of the word ‘include’ in the legislation was critical as it meant that the circumstances listed in FA 1965, Sch 7, para 4(1)(a) were not an exhaustive list of transactions that amounted to a reorganisation, merely a statement of circumstances that were to be taken as being reorganisations for tax purposes. Balcombe LJ stated in his judgment that the phrase ‘reorganisation of a company’s share capital’ is ‘not a term of art’, but ‘it derives colour from its context’. To explain the colour of that context, he reviewed the remainder of FA 1965, Sch 7 and stated that: ‘We are left with the clear impression that the policy behind those paragraphs of Schedule 7 to which we have referred is that, for the purposes of capital gains taxation, there shall not be a disposal of the original holding, or the acquisition of the new holding (or any deemed disposal or acquisition) where the shareholders remain the same and they hold their shares in the same proportions, notwithstanding that the number of the shares increases (a reorganisation or conversion) or decreases (a reduction) within the same company, or the old shares are replaced by new shares in the company which effectively replaces or represents the old one (takeover, reconstruction or amalgamation)’. The Court of Appeal therefore agreed with the company and approved of the view that ‘the continued identity of the shareholders holding their shares in the same proportions’ was ‘the essential feature of a reorganisation of capital’2. In this instance, the judge used the principles to be derived from the scheme of the legislation to reach the conclusion that the term ‘reorganisation’ is not exhaustively defined in the code itself, but rather should be interpreted in the manner that makes sense of that code as a coherent system of taxation. The result was, in that case, to extend the meaning of the term3. This decision was reaffirmed in the recent case of Joanne Elizabeth Fletcher v HMRC ([2008] SpC 00711). In this case, two individuals started a trade in 136

Introduction to reorganisations 5.4 a newly incorporated company which had an initial subscription of 400 £1 ordinary shares for each individual and a loan of £50,000 from each. Following incorporation, the company accrued trading losses but a corporate investor was persuaded to invest £250,000, which was split between 150,000 preference shares and 100,000 A ordinary shares. Under the terms of this investment, each individual shareholder was required to capitalise their loan accounts and take £50,000 B ordinary shares, instead. The B shares had voting rights and a restricted right to dividends. The company was subsequently liquidated and Ms Fletcher made a claim for an allowable loss of £50,000 on the B ordinary shares to be set against her taxable income. The Revenue refused the claim, largely because they took the view that the B shares were worthless when issued and could not, therefore, have become worthless at some later date. This was on the basis that, in order to ‘become of negligible value’ under TCGA 1992, s 24(2), the shares had to have had an earlier value. The Revenue’s view was based on both the restricted rights attached to the shares and on the loss position of the company at the time of subscription, which the Revenue contended meant that the company (and, by extension, its shares) was valueless. The Special Commissioner held that the issue of B shares was a ‘reorganisation’ under TCGA 1992, s 126, following the ratio in the Young, Austen & Young case, as the shares were issued to the holders of ordinary shares pro rata to their original holdings. The significance of this is that a large part of the Revenue’s argument then fell away, as it was not necessary to consider the initial value of the B shares when they were issued. Instead, the reorganisations rules require us to look at the value of the ‘new holding’, ie the aggregate shareholdings of ordinary and B ordinary shares. So the fact that the bulk of the value was in the ordinary shares, and the B shares were potentially worthless when considered in isolation, was irrelevant. The Commissioner went on to decide that the valuation assumed by the third party investor was sufficient evidence that the company was also not worthless at the time of the investment, so that Ms Fletcher’s investment was worth at least £50,400 in aggregate at that point. Her appeal was allowed. This case is discussed in further detail at 6.15 below. The other question we might ask is whether a reorganisation would anyway give rise to a disposal absent this particular relief, ie does the question ‘is this a reorganisation for tax purposes?’ necessarily suppose that there would otherwise be a tax charge? This is not entirely an academic question, particularly in the context of transactions such as share-for-share exchanges and other transactions that are treated as reorganisations for tax purposes.

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5.4 Introduction to reorganisations The simple answer is, of course, ‘maybe’! That is, it is possible to convert the rights pertaining to a share or a security into different rights without there being any actual disposal of the original holding. On the other hand, in legal terms, it is also possible to change the rights on a share or security by cancelling the share or security and issuing a new one with the required different rights. Furthermore, it appears that it is sometimes necessary as a matter of company law to follow the cancellation and reissue route, for example, when converting a non-redeemable share with a redeemable share. So it is more sensible to have a legislative approach that treats all reorganisations as not involving any disposal or acquisition than somehow to try and distinguish between different legal forms with the same economic consequences. This question was considered briefly in the 2002 case of Unilever (UK) Holdings Ltd v Smith 76 TC 300. The case is discussed in more detail in Chapter 6, but Jonathan Parker LJ in the Court of Appeal was asking whether a reorganisation necessarily had to involve a disposal to fall within the relieving provisions of TCGA 1992, s 127. He said that ‘a “new holding” can only “result” from a “reorganisation” where the arrangements under consideration would, but for section 127, involve an element of disposal or acquisition … As I see it, nothing short of that will do’. Does this mean that there can only be a reorganisation for the purposes of TCGA 1992, ss 126 et seq where there would otherwise be a disposal (or acquisition) for capital gains tax purposes? It seems unlikely that the judge meant to go quite that far. We suspect that the clue is in the phrase ‘an element of disposal or acquisition’: he was not referring exclusively to an actual disposal, either in the technical sense or in the commercial sense. Instead, ‘an element of disposal or acquisition’ can include a change to an asset such as a reduction or increase of the rights of a shareholder. Thus, we have a working definition of a reorganisation for the purposes of this book: ●●

a reorganisation can be taken as the company organising its share capital differently (the plain English approach);

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a reorganisation can apply separately to any class of share capital (from company jurisprudence and from the legislation);

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a reorganisation can include converting share capital into other securities but not vice versa (from the legislation4);

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a reorganisation requires the continued identity of the shareholders (of each class) holding their shares in the same proportions (from the Young, Austen & Young case); and

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a reorganisation requires an element of disposal or acquisition (from the Unilever case). 138

Introduction to reorganisations 5.5

1 Although in 1892, in the Hooper case, we were told that ‘reorganisation’ was not a term of art. Presumably, things had moved on by 1962. 2 To counter the potential for avoidance opened up by this decision, the market value rule now in TCGA 1992, s 128(2) was introduced. 3 One might also see this as an example of a purposive approach to statutory interpretation, given Balcombe’s references to the policy behind the statutory provisions. 4 But see Chapter 7 for the specific legislation covering conversions of securities.

PURPOSE OF THE LEGISLATION 5.5 No reason is given in the Notes on Clauses for this exception to the general rules on disposals. However, there is a clear logic to these rules. The fundamental basis of the taxation of chargeable gains is that a tax charge arises on the numerical difference between the consideration for the disposal of an asset and its acquisition cost, as adjusted if necessary in accordance with the terms of the relevant legislation. What about transactions where there was a disposal or at least a change in the nature of the asset that might constitute a disposal, but where there was no real change of ownership and/or no actual consideration for the transaction, such as a reorganisation of a company’s share capital? It is clear that there was a policy decision that such transactions should not be chargeable to tax (see Figure 5.2). Figure 5.2

A logical reason is, perhaps, the assumption that there has not been any real disposal. If a person owns 100 per cent of the ordinary share capital of a company and some of the shares are converted to, say, preference shares, that person still holds all of the share capital of the company. So has there been a real disposal? What about the situation where the share capital is owned by more than one person and one person’s holding is converted into another form (as in Figure 5.3)? 139

5.5 Introduction to reorganisations Figure 5.3

In this case, the holder of the preference shares has now got preferential rights to dividends and profits, so could be said to have given up the rights of an ordinary shareholder in return for enhanced rights. So this transaction could be seen as a form of disposal. Indeed, in this case one can also see that the other shareholder has given up rights too, as that person’s shares no longer rank pari passu with the shares of the preference shareholder. This is in part the genesis of the value-shifting legislation in TCGA 1992, s 29. Alternatively, the question can be put the other way: ‘Why would Parliament wish to tax such a transaction?’ Reorganisations have long been commercially important transactions which permit companies a high degree of flexibility in their capital structure. It seems reasonable to suppose that Parliament did not want to remove this flexibility by imposing a tax burden where none had existed before. If we view the transaction simply in the context of the Young, Austen & Young case, however, the whole thing becomes much clearer. The company’s share capital has been reorganised, and there are still the same two shareholders holding the same proportion of the company’s share capital, each. The rights imparted by the shares are not relevant in this context, it is only the capital. that we look at. On that basis, this transaction is a reorganisation. As we have seen, this issue was confronted in relation to corporate reorganisations in the original 1962 legislation on short-term gains and the way that it was dealt with then has shaped all subsequent tax legislation on this subject. Judicial authority for these propositions is found in NAP Holdings UK Ltd v Whittles1 67 TC 166 where the purpose of the sections was described by Lord Jauncey as follows: ‘The underlying philosophy of the sections is not hard to discern. It is to secure that shareholders in companies which are involved in reorganisations of share capital or which are subject to amalgamations or takeovers do not incur chargeable gains on disposals over which they have little or no control. Only when they later dispose of the new shares will a chargeable gain arise.’ 140

Introduction to reorganisations 5.6

1 See Chapter 8 for a more detailed look at this case.

ACHIEVING PARLIAMENT’S INTENTION 5.6 The central concepts of the original legislation (in FA 1962) for the taxation (as income) of short-term gains required the identification of separate assets and of the timing and costs of their acquisition and disposal. This was initially relevant in the context of a tax that defined taxability in terms of a period of ownership, but most of these factors remained relevant when capital gains tax was enacted in FA 1965, Sch 7. An important issue here is to remember that this legislation operates to the benefit of the shareholder of the company that is reorganising its share capital, ie there are generally no tax consequences to the company carrying out the reorganisation, only to the shareholder, so it is the shareholder that needs protection from being treated as having made a disposal if Parliament has decreed that the reorganisation should not be taxable. The key point here is that once the decision had been taken to identify particular assets and then define their taxability in terms of their acquisition and disposal, it follows logically that if it was deemed that a transaction should be non-taxable, it was necessary to find a mechanism to achieve that aim. One way of doing that would simply be to deem a transaction to be exempt from tax, but this would not work if you wanted the assets concerned to remain taxable on their eventual disposal. To do this, you would need a tax history for the asset – a date of acquisition and a cost to be used to assess the gain on the ultimate taxable disposal. To do that, it became necessary to deem a new asset to be the original asset with all its history. ‘Assets’ for capital gains purposes became curiously abstract objects, especially if they had been through, or were the product of, a reorganisation. To describe the tax basis of such an asset, it is now necessary to trace its history through earlier incarnations, potentially through any number of reorganisations under which a parcel of shares or securities had been increased, reduced or exchanged for another while remaining, for tax purposes, a single asset. It is essential, however, to be able to demonstrate that the facts in question are a reorganisation. This was demonstrated in Vinton v Revenue and Customs Commissioners [2008] WL 371054 which involved business property relief in inheritance tax and whether the acquisition of 1,000,000 £1 shares two days prior to death had arisen from a reorganisation, under TCGA 1992, s 126. Had this been the case, the deceased would have been treated as having held these

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5.7 Introduction to reorganisations shares for the required two-year period to qualify for relief (as was the case for a £300,000 investment by way of a rights issue only four days earlier). The executrices of the estate submitted that a rights issue could be deemed to have been agreed by all the company members under the Duomatic principle (which allows certain formalities to be treated as satisfied by way of informal approval by a company’s shareholders). This was dismissed by the Special Commissioners on the basis that, since the members had not understood the relevant facts concerning the concept of rights issues and business property relief, the Duomatic principle could not be applied so as to give the character of a rights issue to what was expressed as a share subscription. A separate transaction within this case is discussed in further detail at 6.11 below.

CONCLUSION 5.7 This brief historical overview shows how a term that is not defined in company law or jurisprudence was nevertheless used as if it were a term of art in tax legislation. While this might seem a somewhat cavalier way to write legislation – and is in marked contrast to the concept of a reconstruction which had been considered by the courts many times in the context of company law1 – it does not appear to have caused many difficulties. Indeed, the substantive question of whether a transaction amounted to a reorganisation has rarely had to be considered once by the courts. This legislative approach also has the theoretical advantage of giving the judiciary the flexibility to consider each case on its own merits, despite the fact that this flexibility has not had to be tested. Conversely, from the perspective of the taxpayer, it might be thought that a tighter definition of ‘reorganisation’ might generate more certainty of application of the various legislative provisions. Once again, however, we would note that even in practice we have rarely had to consider whether a transaction constitutes a reorganisation, so it seems churlish to complain. What this brief review does is to show how the concepts of corporate reorganisations pre-date any attempt to capture their nature in tax legislation. However, business people must now take into account the frequently artificial concepts of tax legislation as they decide how to structure their commercial dealings. The transactions that commercially constitute a reorganisation become relevant for tax purposes to the extent that they potentially give rise to tax consequences; the reliefs that relate to reorganisations therefore go hand in hand with the provisions that give rise to such tax consequences.

1 See Chapter 15.

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Chapter 6

Reorganisations of share capital

INTRODUCTION 6.1 The purpose of this chapter is to explore the various circumstances in which a company may seek to adjust its capital. As we have seen from the last chapter, the meaning of ‘reorganisation’ has developed as a matter of commercial practice with a tax law overlay. As a matter of simple commercial parlance, any number of types of transactions may be talked of as a ‘reorganisation’ or at least take place in the context of arrangements that indisputably constitute a reorganisation. The question as to whether, as a matter of tax law, a particular transaction constitutes by itself a reorganisation depends on whether it is within the tax meaning of ‘reorganisation’ and, where necessary, how it is construed by the courts.

THE LEGISLATION 6.2 First, the legislation defines what is intended by the word ‘reorganisation’ in TCGA 1992, s 126 before addressing the tax consequences of a reorganisation in TCGA 1992, s 127. TCGA 1992, s 128 explains how to deal with consideration paid by or to a shareholder in a reorganisation and TCGA 1992, ss 129 and 130 give computational rules for the apportionment of the base cost of the original shares between the different components of the new holding. Finally, TCGA 1992, s 131 makes a necessary adjustment to the rules relating to indexation allowance (though noting that indexation allowance for companies now only accrues to 31 December 2017). Towards the end of this chapter we have put together a series of examples to demonstrate the way in which the legislation works in practice.

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6.3 Reorganisations of share capital TCGA 1992, s 126(1) – application of sections 127 to 131 6.3 ‘(1) For the purposes of this section and sections 127 to 131 “reorganisation” means a reorganisation or reduction of a company’s share capital, and in relation to the reorganisation – (a) “original shares” means shares held before and concerned in the reorganisation, (b) “new holding” means, in relation to any original shares, the shares in and debentures of the company which as a result of the reorganisation represent the original shares (including such, if any, of the original shares as remain).’ Analysis 6.4 Meaning of reorganisation As we have already seen, the key issue here is to protect the concept of a reorganisation from taxation while preserving the right to tax the disposal of the successor asset(s) when they are eventually disposed of by a taxable transaction, so these provisions are a deferral mechanism, rather than an exemption such as SSE. This is done in TCGA 1992, s 126(1) by defining a reorganisation and some of the terms associated with it. First, as we have seen, ‘reorganisation’ is not specifically defined itself, so we have to rely on the factors identified in the last chapter: ●●

a reorganisation can be taken as the company organising its share capital differently (the plain English approach). This is demonstrated in Example 6.1 at 6.28 below;

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a reorganisation can apply separately to any class of share capital (from company jurisprudence and from the legislation);

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a reorganisation can include converting share capital into other securities. Strictly, the opposite does not apply, but there are tax provisions, such as TCGA 1992, s 132, that treat a conversion of securities into shares or into other classes of securities as if it were a reorganisation (see Chapter 7);

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a reorganisation requires the continued identity of the shareholders (of each class) holding their shares in the same proportions (from the Young, Austen & Young case); and

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a reorganisation requires an element of disposal or acquisition (from the Unilever case). 144

Reorganisations of share capital 6.6 We will look in more detail at the meaning of a reduction of capital when we look at TCGA 1992, s 126(3). But the general principle is that if share capital is simply cancelled and replaced by some other form of instrument that represents the capital of the company, the transaction is treated as a reorganisation and the replacement instrument is treated as though it were the original asset and no disposal has taken place. And if there is no replacement instrument, such as on a reduction, the reduction is treated as not involving a disposal. If, on the other hand, some form of value has passed out of the company to shareholders, then there is no policy reason why this distribution of value should not be taxed (either as an income distribution or as a capital receipt). Parliament clearly did not intend to protect such ‘natural’ disposals from taxation and explicitly provides for them to be taxed. As we shall see, this can be achieved in two ways. Either a transaction is treated as a disposal and not a reorganisation, as in a redemption of redeemable share capital (see TCGA 1992, s 128(3) below), or the transaction is treated as a reorganisation but any cash consideration is taxed under TCGA 1992, s 128, as in a share buy-back (see Example 6.8 at 6.28 below). TCGA 1992, s 126(2) – expanded meaning of ‘reorganisation’ 6.5 ‘(2) The reference in subsection (1) above to the reorganisation of a company’s share capital includes – (a) any case where persons are, whether for payment or not, allotted shares in or debentures of the company in respect of and in proportion to (or as nearly as may be in proportion to) their holdings of shares in the company or of any class of shares in the company, and (b) any case where there are more than one class of share and the rights attached to shares of any class are altered.’ Analysis 6.6 TCGA 1992, s 126(2) expands the meaning of reorganisation to two further cases, neither of which would qualify as a reorganisation under first principles, as established in Young, Austen & Young. Does this mean that these are the only mechanisms for increasing share capital that are to be treated as reorganisations for these purposes? The significant 145

6.6 Reorganisations of share capital factor is the inclusion of the word ‘includes’ which can be interpreted in two ways: ●●

added to the general case in TCGA 1992, s 126(1), we have two and only two cases of an increase in share capital that are to be treated as reorganisations (ie TCGA 1992, s 126(2) is an exhaustive extension of s 126(1)); or

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the general meaning of reorganisation in TCGA 1992, s 126(1) can include certain increases in share capital but, for the avoidance of doubt, the transactions mentioned in TCGA 1992, s 126(2) are specifically brought within the scope of section 126 (ie TCGA 1992, s 126(2) is a non-exhaustive list of circumstances, some of which are already covered by s 126(1)).

This was the main point of debate in the Young, Austen & Young case. The taxpayer argued that the transaction was a reorganisation within the general TCGA 1992, s 126(1) meaning, while the Revenue argued that only increases in capital within TCGA 1992, s 126(2) could be reorganisations for the purposes of the relief. As we have seen, the taxpayer won that argument and it is now accepted that the general meaning of a reorganisation can include share increases, even if they are not within TCGA 1992, s 126(2). That is, we interpret TCGA 1992, s 126(2) according to the second bullet point, above. Turning now to the special cases mentioned in TCGA 1992, s 126(2), the first covers an increase in capital by the allotment of shares or debentures in respect of, and in proportion to, the original holding and would include bonus issues, rights issues and similar transactions (see below). The second case referred to is where there is more than one share class and the rights attached to shares in any class are altered. This puts it beyond doubt that a company can reorganise its share capital as a whole or it can choose to reorganise any class of shares. The reference to the alteration of rights is important, however, as the cancellation of a class of share – as in the Unilever case – is not an alteration of rights. The word ‘debenture’ has been occasionally considered by the courts, usually in the context of stamp taxes (and often posed quite a headache). The word first appeared in statute in the late 19th century and was the key matter of debate in The British India Steam Navigation Company v The Commissioners of Inland Revenue (1881) 7 QBD 165 where, for the Appellants, Wills, QC stated that ‘The Stamp Act gives no definition of “debenture;” nor is any precise definition of the word to be found in any of the dictionaries: it seems to be a word of modern introduction, and more properly perhaps applicable to a charge upon property’. 146

Reorganisations of share capital 6.6 It would appear that not much has changed in the 139 years between the British India Steam Navigation case and the present date, with the definition of the word ‘debenture’ still not being very clear in the context of UK tax and with no precise definition in any of the legal dictionaries. The dictum from the British India Steam Navigation case thus remains the most comprehensive definition in the context of tax. In giving his judgment, Lindley J made the following statement which remains as relevant today in the context of conversions as it did in 1881 in the context of stamp duty: ‘Now, what the correct meaning of “debenture” is I do not know. I do not find anywhere any precise definition of it. We know that there are various kinds of instruments commonly called debentures. You may have mortgage debentures, which are charges of some kind on property. You may have debentures which are bonds; and, if this instrument were under seal, it would be a debenture of that kind. You may have a debenture which is nothing more than an acknowledgment of indebtedness. And you may have a thing like this, which is something more; it is a statement by two directors that the company will pay a certain sum of money on a given day, and will also pay interest half-yearly at certain times and at a certain place, upon production of certain coupons by the holder of the instrument. I think any of these things which I have referred to may be debentures within the Act.’ This judgment would suggest that a mere ‘acknowledgement of indebtedness’, which appears to be very similar to the definition of a security, albeit without the requirement that there be a document, could be sufficient to constitute a debenture. This raises an interesting question on the extent to which an acknowledgment of indebtedness is sufficient to constitute a debenture for the purposes of the Taxes Acts. One important question is whether TCGA 1992, s 135 could apply where there is not a formal loan note in a transaction but rather the acknowledgement of indebtedness is in a share purchase agreement (SPA) or side letter. For example, a reference to deferred consideration under an SPA could arguably be an acknowledgment of indebtedness. If that is sufficient to constitute a debenture, the reorganisation provisions could apply in circumstances where the commercial intention is that they do not, such as when the outstanding consideration is intended to be a debt simpliciter. The answer is, of course, dependent on the underlying facts of the case at hand and, in the view of the authors, the question of whether or not a form of debt constitutes a debenture is a matter of law. It is therefore vital to ensure that the legal counsel drafting the documentation is aware of the tax implications of the consideration being (or not being) a debenture and that commercial responsibility for the question lies squarely with the lawyers. 147

6.7 Reorganisations of share capital In circumstances where debenture treatment is sought, it is likely that taxpayers err on the side of more documentation rather than less, to ensure that the risk of there being any contention that a debenture does not exist is reduced.

Unilever (UK) Holdings Ltd v Smith 6.7 The 2002 case of Unilever (UK) Holdings Ltd v Smith 76 TC 300 is an interesting illustration of some of the consequences of the inclusion of reduction of capital into the definition of a reorganisation. Unilever owned the ordinary capital in a subsidiary, but there was a class of preference shares that was owned by the public (Figure 6.1). These preference shares were cancelled in 1965 under a scheme of arrangement and the shareholders were paid off. It is not clear from the case report whether this was a redemption of redeemable shares, although this seems unlikely if a scheme of arrangement was required. However, whether it was a redemption or a cancellation for consideration, there is no replacement of the shares by new instruments so this transaction was not a reorganisation as far as the relevant shareholders were concerned. They were therefore treated as having made a disposal. Figure 6.1 Unilever (UK) Holdings Ltd v Smith

Unilever contended that this cancellation was a reorganisation for tax purposes comprising a reduction of share capital, under what is now TCGA 1992, s 126(1), so that the ordinary shares held throughout should be treated as comprising a ‘new holding’ for the purposes of the tax legislation. If this was right, then the straight-line apportionment of the gain on the disposal of an asset held on 6 April 1965 would be adjusted to reflect a deemed market value reacquisition of the asset at the time of the reorganisation. To succeed, the company had to establish that in 1965 a reorganisation of share capital had taken place; either the ordinary shares were ‘concerned’ in that reorganisation as the cancellation of the preference shares constituted a reorganisation in respect of which the ordinary shares were concerned, or that rights attaching to the ordinary shares had, at least in economic terms, been varied as a result of the cancellation of the preference shares.

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Reorganisations of share capital 6.8 Unilever failed, however, to establish that any reorganisation had taken place. Jonathan Parker LJ, in the Court of Appeal, referred to the opening words in TCGA 1992, s 126: ‘for the purposes of this section and sections 127 to 131 “reorganisation” means a reorganisation or reduction of a company’s share capital’ and went on to note the requirement in TCGA 1992, s 126(1)(b) that there be a new holding that represents the original shares and the fact that TCGA 1992, ss 127–131 are all about how this new holding is to be treated. He said that this meant that the term ‘reorganisation’ could only apply to a transaction to which the composite asset fiction of TCGA 1992, s 127 could be made to apply. In other words, unless there was an identifiable new holding, there could be no reorganisation, and a new holding must be different from the original holding in some way, ie the original holding must be ‘concerned in the reorganisation’ as required by TCGA 1992, s 126(1)(a). So, even if a reduction of capital does not have to satisfy the tests in Young, Austen & Young, it still had to have an element of disposal or acquisition, or have an alteration of rights to which TCGA 1992, s 126(2)(b) would apply, so that there is some difference between the new holding and the original shares. In Unilever’s case, while the preference shares had been cancelled, this had no dispositive or acquisitive effect on the ordinary shares; the existing ordinary shares had been neither added to nor subtracted from. Thus, the ordinary shares could not be said to be ‘concerned in the reorganisation’, so there could be no new holding and therefore no reorganisation. So we have two important concepts from this case. First, it is a helpful illustration of what constitutes a new holding; it is a holding of shares or securities that differs in some way from the original holding. However, Jonathan Parker LJ goes further than that and essentially says that the new holding is the crux of this legislation – if there is no new holding, then there cannot be said to be a reorganisation. Finally, it is also clear that the original shares must be concerned in the reorganisation whereby the new holding is created.

Increases in capital 6.8 Referring back to TCGA 1992, s 126(2)(a), it seems likely, following the decision in the Young, Austen & Young case, that an issue or allotment that complies with the terms of the provisions would, in any case, be a reorganisation from first principles – under TCGA 1992, s 126(1) – as part of the ratio in that case was that new shares were issued to the shareholder in proportion to its beneficial holding of original shares (ignoring the nominee shareholding which constituted legal, not beneficial, ownership). Indeed, there would not have been a need for a tax case had the reorganisation been structured as a 149

6.9 Reorganisations of share capital rights offer. So TCGA 1992, s 126(2)(a) might be seen as taking the matter beyond doubt. There are a number of mechanisms available for a company to increase its share capital.

Bonus issues 6.9 Where a company makes a bonus (or scrip) issue, new shares are issued to existing shareholders for no consideration. Typically, this is achieved by capitalising reserves, which might be for corporate law purposes whereby there is a non-distributable reserve which cannot be otherwise utilised. A bonus issue can also form part of a wider transaction, for example, splitting existing shares into shares of a lower nominal value, which might be helpful where an additional minority shareholder is to be introduced. TCGA 1992, s 126(2)(a) means that a bonus issue is treated as a reorganisation so long as the new shares are issued in proportion (or as nearly as may be in proportion) to shareholders’ existing holdings. In a simple case, such as in Figure 6.2, this is straightforward and TCGA 1992, s 126(2)(a) does not add anything to TCGA 1992, s 126(1), following Young, Austen & Young Ltd. Figure 6.2

The qualification to the proportionality requirement, however, allows the reorganisation provisions to apply to situations where it is not possible to issue shares in exact proportions (see Figure 6.3). Figure 6.3

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Reorganisations of share capital 6.9 In this case, a 1-for-10 bonus issue means that the 51:49 proportionality at the start is lost, as after the bonus issue the proportions are 56:53. However, the phrase ‘or as nearly as may be in proportion’ means that the transaction is nevertheless treated as a reorganisation, despite failing the primary condition from the Young, Austen & Young Ltd case. If the bonus issue falls within TCGA 1992, s 126(2)(a), then under TCGA 1992, s 127 the original shares and the new holding are to be treated as the same asset. The practical effect of this is that the acquisition cost of the original shares is allocated across the new holding (see Example 6.2 at 6.28 below). This is commonly referred to as a ‘stand in shoes’ treatment and acts on the premise that there is no disposal of the shares. The obvious question that may arise is, why do a bonus issue? This is best illustrated by an example of a firm of accountants who had incorporated in 1993, issuing one £1 share in the new company to each of the three ‘partners’. This did not give rise to any problems until 20 years later, when one of the shareholders had retired and taken a lump sum by way of a company purchase of own shares. The two remaining partners decided they wanted to promote at least one existing member of staff to a director role, and also for that person to have a stake in the business. Of course, since there were now only two issued shares, to give another person even a single share would immediately give them one third of the company, which was not the preferred option. A number of options were mooted but the shareholders’ preference was to issue bonus shares, so that they would each hold, say, 10,000 ordinary shares. Such a bonus issue would be on a completely pro rata basis, ie each shareholder would be issued 9,999 new shares paid up out of reserves, so the company would retain the same shareholders with the same proportionate shareholdings, 50% each, and this would clearly be a reorganisation for tax purposes, as we have seen. This would then allow them to bring on new members of staff and to allow them to acquire shares in the company at a level more acceptable to the existing shareholders. The interesting problem that arises, in this case, is that the issue of shares to shareholders who happen to be directors could potentially trigger a charge under the employment-related securities rules (ITEPA 2003, Part 7). That is because the bonus shares are being issued for no consideration. In this context, ITEPA 2003, s 421D(3) is helpful, as it effectively states that the diminution of value of the original shares is treated as paying up the bonus shares for the purposes of the employment-related securities legislation, so that in many cases such a bonus issue will not cause a problem. However, ITEPA 2003, s 421D(1) states that this applies only where the original shares are, themselves, employment-related securities, which will not be the case if they were issued 151

6.10 Reorganisations of share capital before 2003, when the relevant legislation came into force. Nevertheless, HMRC’s manuals at ERSM 20440 imply that, in these cases, HMRC is still likely to take the same view. But since this is not a statutory provision, it may be as well to check, perhaps by obtaining a pre-transaction clearance under the non-statutory clearance facility. Another example that we have seen is where a company has an equity reserve which is not distributable as a company law matter but can be used to pay up shares under a bonus issue. A subsequent cancellation of these shares (by way of a solvency statement-based reduction of capital) will result in the creation of distributable profits equal to the nominal amount of the share capital cancelled, which should then be capable of being distributed to the shareholders as a dividend. Although fact- and circumstances-specific and dependent on the company law and accounting treatment, a bonus issue can often be used to ‘unblock’ a dividend block. This can be a useful mechanism where there is uncertainty as to whether a reserve is distributable or not.

Rights issues 6.10 In a rights issue, a company gives existing shareholders the opportunity to subscribe for further shares in the company. Often, the rights issue is priced at a discount to the current market price as an incentive for shareholders to take up the offer. Normally, a provisional letter of allotment is issued to shareholders entitling them to subscribe for further shares. For the application of TCGA 1992, s 126(2)(a) to a rights issue, the reference to allotment, rather than to issue, is important. Suppose a company decides on a rights issue as a way to raise capital. Some shareholders decide to take up the offer, others do not, failing the primary condition from the Young, Austen & Young Ltd case. So, we apparently have a simple increase in share capital which does not constitute a reorganisation for tax purposes. However, once again, we are rescued by the precise wording of TCGA 1992, s 126(2)(a), which refers to persons being ‘allotted shares in or debentures of the company in respect of and in proportion to (or as nearly as may be in proportion to) their holdings of shares in the company’. Regardless of a provisional letter of allotment, referred to above, the actual allotment of shares does not take place until the right is accepted by the shareholders. So the actual allotment is only to those shareholders taking up the rights offer, and shares will be allotted to them in proportion to, or as nearly as may be in proportion to, their shareholdings. In other words, the shareholdings of the shareholders who choose not to take up their rights are simply ignored, permitting a rights issue to be a reorganisation for tax purposes.

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Reorganisations of share capital 6.11 Where rights are not taken up, then they can be sold nil paid. Any receipt from the sale of such rights is a capital distribution under TCGA 1992, s 122 by virtue of TCGA 1992, s 123 (disposal of right to acquire shares or debentures). If the rights issue falls within TCGA 1992, s 126(2)(a), then under TCGA 1992, s 127 the original shares and the new holding are to be treated as the same asset. The practical effect of this, with TCGA 1992, s 128 (below), is that the acquisition costs of the original and the new shares are allocated across the entire holding (see Example 6.3 at 6.28 below).

Vinton and another (executors of Dugan-Chapman (deceased)) SpC 665 6.11 The Vinton case is briefly mentioned at 5.6 above in respect of a share acquisition not being a reorganisation, but it is also a good illustration of the way in which the rules for reorganisations work. Mrs Dugan-Chapman owned 750,500 shares in a company called Wilton Antiques Ltd. She was also owed £300,000 by the company. As a result, steps were taken to organise a rights issue whereby she could subscribe for 300,000 new shares in the company for a total sum of £300,000, which would effectively eliminate the loan account. It was noted that, of course, a rights issue required that other shareholders be entitled to subscribe, but in the event only Mrs Dugan-Chapman did so, on 23 December 2002. This was genuine ‘death bed planning’, as she died on 29 December 2002. The result of the case, however, was that the rights issue was respected as a reorganisation for tax purposes, so that Mrs Dugan-Chapman’s enlarged shareholding was treated as having been held for substantially more than the two years required for inheritance tax business property relief to be available. This is, of course, one of the fundamental features of the reorganisations legislation, that the new holding, in this case Mrs Dugan-Chapman’s holding of 1,050,500 shares, was treated as being the same as the original shares, ie her 750,500 shares, and the entire new holding is therefore deemed to have been held for the same period of time as the original shares. For reasons that are not entirely clear from the case report, a further ordinary subscription of £1 million for one million further shares in the company was made by Mrs Dugan-Chapman on 27 December 2002. As outlined at 5.6 above, since this was a straightforward subscription, and she was not the only shareholder, this did not satisfy the requirements of a reorganisation, so that the newly acquired one million shares did not qualify for business property relief.

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6.12 Reorganisations of share capital

Open offers 6.12 In practice, a company wishing to raise equity finance will often arrange for a share issue to be underwritten by a broker in order to ensure that the necessary funds are raised. Typically, an individual shareholder will be entitled to subscribe for a minimum number of shares based on his existing proportion of the shares and will then be given the opportunity to acquire further shares up to a set maximum from the entitlements of other shareholders which have not been taken up. Any unwanted shares are placed with institutions. Normally, the shares will initially be issued to the broker who first deals with the requirements of the existing shareholders before placing the remainder with the institutions. As such, there is no allotment of shares to existing shareholders and the transaction cannot fall within TCGA 1992, s 126(2)(a). However, HMRC will treat any subscription up to the shareholders’ minimum entitlement as a reorganisation, in accordance with RI 74 (see Example 6.4 at 6.28 below). Any further shares acquired under the open offer are treated as a new acquisition.

Vendor placements 6.13 By contrast, additional shares acquired following a vendor placement will not fall within the reorganisation provisions. This type of transaction is found where a company wishes to issue its own shares to a vendor as consideration for an acquisition, often of a subsidiary company, but the vendor company does not wish to retain those shares. The new shares are initially allotted to the vendor, but are then offered to existing shareholders, often subject to a minimum and maximum entitlement as in an open offer, on the vendor’s behalf. Any shares not taken up in this way will typically be sold on the market. This is not a reorganisation, as shares are not allotted to existing shareholders. Furthermore, there is no HMRC concession to treat it as such.

Combined issues 6.14 The elements of an open offer and a vendor placing may be combined in a single transaction. For example, a company making a major acquisition may also wish to raise additional funds to fund the working capital requirements of the enlarged group. An individual shareholder may therefore acquire shares some of which have been acquired under the open offer element

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Reorganisations of share capital 6.15 of the transaction, whereas others may be acquired as a result of the vendor placing element. In such circumstances, HMRC will apportion the shares acquired between the two elements and the reorganisation provisions will apply to the appropriate proportion. There will be a consequential effect on the base cost of the shares acquired in the hands of the shareholder.

Summary of TCGA 1992, s 126(1) and (2) 6.15 So how do the requirements in respect of original shares and new holdings relate to the previous discussions of what constitutes a reorganisation? As noted in the introduction, what constitutes a company reorganisation is a question both of tax law and of commercial practice. The term has been used to encompass a number of situations. Looking at each, it should be possible to see whether each has original shares concerned in a reorganisation generating a new holding and hence of being a reorganisation for tax purposes: ●●

Where the existing capital instruments are replaced by new capital instruments, whether or not such a replacement is accompanied by an increase or reduction in the assets of the company (Figure 6.4).

Figure 6.4

In this case, the new instruments acquired are different from the old shares held originally, so that it is clear that there is a new holding and original shares and that they are not the same. Furthermore, since the original shares have to be changed in some way, they must be concerned in the reorganisation and, as such, this transaction can clearly be a reorganisation.

●●

Where the terms of existing capital instruments are varied so as to cause their holders to have new rights in respect of the income and capital of the company, whether or not such variations are accompanied by an increase or reduction in the existing assets of the company (Figure 6.5).

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6.15 Reorganisations of share capital Figure 6.5 A

A 100 £1 Fixed-rate A Shares (New holding)

100 £1 ORDS (Original shares) B

B

In this case, clearly the new instruments are again different from the originals due to the change in rights. Again, therefore, it is clear that the original holding is amended so that it must be concerned in the reorganisation. Hence, this transaction must be a reorganisation.

●●

A consolidation of share capital, perhaps following a buy-back or reconstruction (Figure 6.6).

Figure 6.6

This transaction retains the capital base of the company and no value passes into or out of the company. Again, however, the new shares are different from the originals, in this case due to the change of denomination, which is a change of rights. Again, therefore, it is clear that the original holding is changed and that it must be concerned in the reorganisation. Hence, this transaction can (or, indeed, must) be a reorganisation.

●●

A simple increase in the assets of the company where such an increase is accompanied by an issue of new capital instruments, whether or not for new consideration (Figure 6.7).

Figure 6.7

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Reorganisations of share capital 6.15

In this case, there are new instruments issued, although the original shares are still held. If the new instruments are issued in respect of the original shares in some way, such as a bonus issue, then we would say that the original shares are concerned in the reorganisation and the transaction is a reorganisation for tax purposes.

It is possible for an increase in capital to be simply that and not a reorganisation. For example, if a new investor subscribes for shares in a company, then there are no original shares (ie that investor does not have shares before the subscription), so this cannot be a reorganisation. Similarly, even if an existing shareholder subscribes for further shares, unless it is a rights issue or similar offer, then the original shares cannot necessarily be said to be concerned in the reorganisation, so a simple subscription does not prima facie qualify as a reorganisation. This was the case for the £1 million subscription made by Mrs Dugan-Chapman the day before her death in the Vinton case.

So when does a simple subscription constitute a reorganisation? It would seem to be clear that the Young, Austen & Young case (Chapter 5) tells us that a subscription by the only shareholder of a company is likely to be a reorganisation, regardless of whether it is formally a rights issue. So, for example, TCGA 1992, s 128 will apply in the context of determining the base cost of the shares issued.

This was reaffirmed by the Special Commissioner in the case of Fletcher v HMRC which was discussed at 5.4 above. Neither party cited the Young, Austen & Young case in arguments but the Special Commissioner realised that that case was vital, in that it demonstrated that the capitalisation by Ms Fletcher was in fact a reorganisation, as it would not have been carried out in the absence of her existing ordinary shareholding, and so it could be argued that the new shares were issued ‘in respect of the old shares’ within the terms of TCGA 1992, s 126(2). The important point to note here is that both shareholders capitalised their loan accounts to the same extent, so there was equal treatment of all shareholders, one of the key indicia of a reorganisation.

The result was the new value given for the capitalisation flowed into the ‘new holding’ of shares which consisted of the old ordinary shares and the new B shares. Crucially, TCGA 1992, s 128(2) – enacted largely as a result of Young, Austen & Young – says that the base cost of the new holding in a connected-party transaction cannot exceed ‘the amount by which the market value of the new holding immediately after the reorganisation exceeds the market value of the original shares immediately before the reorganisation’. In this case, the Special Commissioner decided that the new holding, comprising both the original shares and the newlyissued B shares, was worth at least the total of £50,000 capitalised, so the low value of the B shares by themselves did not matter. As a result, Ms Fletcher was allowed her capital loss. 157

6.15 Reorganisations of share capital

It may be that in future this decision will be regarded as one that was decided on its own special facts, but as it stands it provides a striking example of a case where a reorganisation was discovered on a simple share issue.

However, if one of the shareholders of a company makes a simple subscription for shares, that does not appear to be a reorganisation, unless the opportunity had been afforded to all the shareholders equally. If it is necessary in a specific case for a subscription to be a reorganisation, we suggest that there should be a preliminary reorganisation, whereby the shares are reorganised into separate classes. The holder of the specific class of share could then subscribe for further shares. Following the Young, Austen & Young decision, that subscription should be a reorganisation but, for certainty of treatment, it might be sensible to arrange the subscription as a rights issue in respect of that class of shares.

●●

A simple reduction in the capital of the company, whether or not such a reduction is accompanied by the redemption, repayment, repurchase or cancellation of existing capital instruments and whether or not there is any repayment, in cash or in kind, to the shareholders (Figure 6.8).

Figure 6.8

This is a more problematic situation as can be seen from the difficulties already discussed above. In a simple case such as Unilever, if a single class of shares is cancelled, it is unlikely that there will be a reorganisation for the reasons discussed in that case. However, what if a company only has ordinary shares and it is decided that the share capital be reduced by half, say by cancellation, for no consideration? This can be achieved in two ways. If the nominal value of each share is halved, say from £1 to 50p per share, then the original shares are clearly changed and therefore we can say that there is a new holding and that the original shares were 158

Reorganisations of share capital 6.15 concerned in a reorganisation (Figure 6.8(b)). Furthermore, TCGA 1992, s 126(3) (which is discussed in further detail below) is not in point as this is not the redemption of redeemable shares.

What if it is decided instead to cancel half the shares and leave the company with half the number of shares with the same original denomination (Figure 6.8(a))? As discussed above, TCGA 1992, s 126(3) only applies to a redemption of redeemable share capital, so a cancellation of half the shares with no consideration is not caught by TCGA 1992, s 126(3), as it is not a redemption and, in any case, the shares concerned are not redeemable. But the shares in the original holding that are not cancelled might be said not to have been concerned in the reorganisation and, since they are unchanged, they might also be said not to be a new holding on the basis of the Unilever case.

However, our view is that one must look at both the original shares and the new holding as composite assets. We infer this both from the wording of TCGA 1992, s 126(1), that a ‘reorganisation’ includes a reduction of capital and that the original shares and the new holding are each to be ‘taken as a single asset’. So one must look at the original holding of X shares and note that the entire holding of original shares was subject to the cancellation of half the share capital. Thus, after the cancellation, the new holding comprises X/2 shares and this is clearly different from the original holding of X shares.

●●

Where a company that has only one class of shares decides to convert some, but not all, of the shares to a new class of shares.

This does not fall into TCGA 1992, s 126(2)(b), which requires as its starting point more than one class of share. So does the conversion of half the ordinary shares into preference shares constitute a reorganisation for tax purposes (Figure 6.9)? Where half of each shareholder’s original holding is converted into A shares, the answer appears reasonably straightforward on the basis of the case above, being akin to half the original holding being cancelled. So we would say that this is clearly a reorganisation for tax purposes.

Figure 6.9

What if one shareholder wishes to retain ordinary shares and the other wishes to have A shares (Figure 6.10)? Using the approach derived from 159

6.16 Reorganisations of share capital Young, Austen & Young, and accepting that we only look at the share capital (see Figure 5.3), we would argue that this example satisfies the requirement that ‘the shareholders remain the same and they hold their shares in the same proportions’ (from the judgment of Balcombe LJ), so we satisfy the tests at first glance.

Another approach is to look at each shareholder individually; one shareholder has a holding of original ordinary shares and a new holding of A shares, so that one shareholder’s shareholding has been subject to a reorganisation. The other shareholder has an unchanged shareholding and has not been subject to a reorganisation. If we only look at the shareholder whose shares were changed, however, we still have the same shareholders holding the same proportion of the company’s capital.

Figure 6.10

Whatever the right answer, this sort of reorganisation is very common, especially as a step in a demerger, and we have never seen the Revenue challenge the transaction as being anything other than a reorganisation.

TCGA 1992, s 126(3) – explanation of ‘reduction of share capital’ 6.16 ‘(3) The reference in subsection (1) above to a reduction of share capital does not include the paying off of redeemable share capital, and where shares in a company are redeemed by the company otherwise than by the issue of shares or debentures (with or without other consideration) and otherwise than in a liquidation, the shareholder shall be treated as disposing of the shares at the time of the redemption.’ Analysis 6.17 As we have seen, TCGA 1992, s 126(1) includes a reduction of a company’s share capital within the meaning of ‘reorganisation’. TCGA 1992, s 126(3) restricts the meaning of ‘reduction of share capital’ so that the paying off of redeemable share capital is not a reduction of share capital and is therefore not treated as a reorganisation for the purposes of TCGA 1992,

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Reorganisations of share capital 6.17 ss 126 et seq. Instead, such a redemption is treated as a disposal for tax purposes, which means that reorganisation treatment is not available. In such a case, we would expect the normal disposal provisions to apply, with any consideration received by the shareholder being taken into account in the computation of the gain. Presumably, also, if the shareholder is deemed to have accepted the cancellation of the shares on non-commercial terms, the market value of the shares can be imposed by TCGA 1992, s 17 (bargains made other than at arm’s length). One exception to this rule is that, if the consideration for the redemption of the redeemable shares is newly issued shares or debentures,1 the normal reorganisation rules can apply. This is specifically provided for by the phrase ‘otherwise than by the issue of shares or debentures’. Thus the ‘redemption’ of redeemable shares by issuing new share capital or debentures will not be excluded by TCGA 1992, s 126(3) and will be a reorganisation within the normal terms of TCGA 1992, s 126(1). TCGA 1992, s 126 is silent about the treatment of any other reduction of capital (ie other than the redemption of shares). We infer from this that TCGA 1992, s 126(1) would appear to potentially apply to any reduction of capital other than a redemption.2 However, this is not wholly the case, as illustrated by the case of Unilever (UK) Holdings Ltd v Smith (see 6.7). It is important to consider what is meant by paying off redeemable share capital. Clearly, if share capital is redeemed as envisaged at issue, we are within this provision. However, is redeemable share capital ‘paid off’ if it is cancelled for no consideration or if only part of the nominal capital is repaid, perhaps because the company is in financial difficulties? In other words, could any of these circumstances constitute a reorganisation for tax purposes where the straightforward redemption of the shares would not? Arguably, cancellation for no consideration does not constitute redemption, since in our view ‘redemption’ must mean the return of the capital subscribed. The situation is not so clear where the capital is partly repaid. In that case, we suspect that the fair view (which HMRC may not agree with) is that this, too, does not constitute a redemption, since not all of the subscribed capital is returned. Therefore, this, too, will be a disposal under TCGA 1992, s 126(3) and the transaction should constitute a reorganisation. See Examples 6.5 and 6.6 (at 6.28 below) which demonstrate some of the principles discussed here. The other exception to the rule in TCGA 1992, s 126(3) is where the shares are redeemed in a liquidation. It is not clear why this specific exemption in respect of liquidations is necessary, as payments on a liquidation are in any case likely to constitute a deemed disposal under TCGA 1992, s 122 and it is hard to see how a liquidation payment can give rise to a reorganisation.

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6.17 Reorganisations of share capital Overall, it seems that the intention of TCGA 1992, s 126(3) is that a reduction of the share capital of a company is not a reorganisation where the transaction is not that of redeeming redeemable shares for full cash consideration. But the reorganisation provisions will apply where non-redeemable share capital is reduced or cancelled or where redeemable shares are exchanged for another capital instrument or redeemed in a liquidation. We also believe that the cancellation or partial redemption of redeemable shares should be a reorganisation, although this is not free from doubt. We note that, in the context of reductions of capital, the distributions legislation also has a number of terms that are used to describe a reduction in the assets of a company. For example, CTA 2010, s 1000(1)B(a) uses the term ‘repayment of capital’ in the context of a test relating to the question of whether a payment out of the assets of the company constitutes a ‘distribution’ for the purposes of the Corporation Tax Acts. Similarly, CTA 2010, ss 1022 and 1026 both refer to the ‘repayment of share capital’, and CTA 2010, s 1033 refers to the ‘redemption, repayment or purchase of … own shares’ implying that each of these are separate concepts. Does a ‘reduction in share capital’ in TCGA 1992, s 126(1) encompass a ‘repayment of share capital’ for the purposes of CTA 2010, s 1000(1)B(a), 1022 or 1026, or a ‘redemption, repayment or purchase of … own shares’ in CTA 2010, s 1033? Similarly, it is not clear whether a purchase of own shares constitutes a repayment of share capital,3 but both questions are of significance in determining the relationship between the capital gains legislation covering reorganisation of share capital with the income tax legislation covering distributions. In the end, the answer may well lie in the order of seniority of the two taxes, income tax and capital gains tax. In general terms, income tax has priority over capital gains tax, so if a transaction is chargeable to income tax, as a distribution in this context, then it will not escape taxation just because it is also a reorganisation for capital gains tax purposes. Conversely, however, there are provisions to ensure that there is no double taxation, so that a transaction should not be charged to income tax as a distribution and also to capital gains tax as not being a reorganisation. The mechanism for securing relief is rather clunky, with TCGA 1992, ss 37 and 39 effectively excluding from the consideration and sums allowable as a deduction from consideration respectively any amounts brought into account for the purposes of ‘income tax’ under the ‘Income Tax Acts’. TCGA 1992, s 2E (which was introduced by FA 2019 and effectively replaces old TCGA 1992, s 8(4)) makes clear that any reference within TCGA 1992 to ‘income tax’ or ‘Income Tax Acts’ in relation to a company is to be read as a reference to ‘corporation tax’ and ‘Corporation Tax Acts’, subject to some minor exceptions.

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Reorganisations of share capital 6.19 In a sense, these provisions might be seen as protection for the unwary taxpayer as it has proved impossible to develop a coherent and consistent scheme of taxation.

1 This ties in with the company law provisions whereby redeemable shares can normally only be redeemed out of distributable reserves or out of the proceeds of an issue of shares or debentures specifically for the purpose of the redemption (Companies Act 2006, s 685). 2 This is a change of view since the publication of the first edition of the book. 3 HMRC’s Manual states that a purchase of own shares does constitute a repayment of share capital (Company Taxation Manual 1571), but this view is disputed by the authors of Bramwell et al, Taxation of Companies and Company Reconstructions (Sweet & Maxwell), section B2.4.

TCGA 1992, s 127 – equation of original shares and new holding 6.18 ‘Subject to sections 128 to 130, a reorganisation shall not be treated as involving any disposal of the original shares or any acquisition of the new holding or any part of it, but the original shares (taken as a single asset) and the new holding (taken as a single asset) shall be treated as the same asset acquired as the original shares were acquired.’ Analysis 6.19 The basic purpose of the section is, as Lord Jauncey remarked,1 relatively simple to follow. The concept of ‘reorganisation’ is used to embrace the circumstances under which it is intended to disapply the tax charge that would arise in circumstances under which the legislative machinery might otherwise regard a disposal, and therefore a taxable event, as having occurred. However, as we have already noted, it is still necessary to be able to charge tax on the eventual disposal of the asset. It was therefore necessary for the statutory machinery to make two forms of adjustment: ●●

any disposal will need to be disapplied for tax purposes – this has become known as the ‘no-disposal fiction’; and

●●

some form of adjustment in the nature of the revised or new asset that is held will need to be made to ensure that the tax charge on any eventual disposal reflects the intervening events – this is achieved by what has been termed the ‘composite asset fiction’.

The basic premise, therefore, is that the disposal rules shall be disapplied when there is a reorganisation of share capital. Instead, the asset that represents

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6.20 Reorganisations of share capital those original shares is deemed to be the same asset as existed before the reorganisation. This is taken to mean that the new holding is treated as having been acquired at the same time and for the same price as the original shares.

1 In NAP Holdings UK Limited v Whittles 67 TC 166, see Chapter 8.

TCGA 1992, s 128 – consideration given or received by holder 6.20 ‘(1) Subject to subsection (2) below, where, on a reorganisation, a person gives or becomes liable to give any consideration for his new holding or any part of it, that consideration shall in relation to any disposal of the new holding or any part of it be treated as having been given for the original shares, and if the new holding or part of it is disposed of with a liability attaching to it in respect of that consideration, the consideration given for the disposal shall be adjusted accordingly. (2) There shall not be treated as consideration given for the new holding or any part of it – (a) any surrender, cancellation or other alteration of the original shares or of the rights attached thereto, or (b) any consideration consisting of any application, in paying up the new holding or any part of it, of assets of the company or of any dividend or other distribution declared out of those assets but not made,

and, in the case of a reorganisation on or after 10 March 1981, any consideration given for the new holding or any part of it otherwise than by way of a bargain made at arm’s length shall be disregarded to the extent that its amount or value exceeds the relevant increase in value; and for this purpose ‘the relevant increase in value’ means the amount by which the market value of the new holding immediately after the reorganisation exceeds the market value of the original shares immediately before the reorganisation.

(3) Where on a reorganisation a person receives (or is deemed to receive), or becomes entitled to receive, any consideration, other than the new holding, for the disposal of an interest in the original shares, and in particular – (a) where under section 122 he is to be treated as if he had in consideration of a capital distribution disposed of an interest in the original shares, or

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Reorganisations of share capital 6.21 (b) where he receives (or is deemed to receive) consideration from other shareholders in respect of a surrender of rights derived from the original shares,

he shall be treated as if the new holding resulted from his having for that consideration disposed of an interest in the original shares (but without prejudice to the original shares and the new holding being treated in accordance with section 127 as the same asset).

(4) Where for the purpose of subsection (3) above it is necessary in computing the gain or loss accruing on the disposal of the interest in the original shares mentioned in that subsection to apportion the cost of acquisition of the original shares between what is disposed of and what is retained, the apportionment shall be made in the like manner as under section 129.’ Analysis 6.21 The basic tax treatment of a reorganisation requires adjustment where consideration is paid by the shareholder for the new holding or by the company to the shareholder in the context of a reduction of capital or a reduction of rights. ‘Consideration’ in this section can either describe the additional value paid by the shareholder or the value extracted from the company. Where it describes extracted value, it is necessary for the legislation to describe how the resulting computation on a disposal must be made. Where it describes additional value, it is necessary to describe the process under which base cost adjustments are made. TCGA 1992, s 128(1) tells us that, where additional value is given for a new holding on a reorganisation, extra consideration is to be treated as having been given for the original shares (as part of the composite asset fiction). The mere incurring of a liability for the additional value is sufficient for such an adjustment. If, however, on a disposal of the new holding, any such ‘liability’ to give such consideration is itself disposed of, the consideration for the disposal is itself adjusted accordingly. The benefit of indexation allowance will not be available in respect of consideration in the form of a liability which is disposed of before it is discharged (see TCGA 1992, s 131 below). Examples 6.3 and 6.4 (at 6.28 below) also demonstrate the operation of TCGA 1992, s 128(1). TCGA 1992, s 128(2) then specifies certain circumstances under which ‘consideration’ cannot be treated as additional base cost for the holding. Alterations of share values by way of the mere surrendering of rights in respect of shares will not constitute such consideration (TCGA 1992, s 128(2)(a)), nor will the application of value which is, in effect, derived from the assets

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6.21 Reorganisations of share capital of the company itself, such as profits or revaluation reserves used to pay up new share capital (TCGA 1992, s 128(2)(b)) (see Examples 6.2 and 6.7 at 6.28 below). The special situation referred to at the end of TCGA 1992, s 128(2) prevents the inflation of base cost of a holding by more than the actual increase in value achieved by an injection of capital on an arm’s-length transaction. This amendment was made as a result of the Young, Austen & Young case (see Figure 6.4) as the £200,000 consideration given for the new shares in that case was greatly in excess of the market value of the shares issued, which was nil (the case was discussed in Chapter 5). The Revenue (or Parliament) clearly decided that the decision for the taxpayer in that case was not in keeping with the rest of the reorganisations legislation and should be amended. The need for an amendment at all was because the normal market value rules of TCGA 1992, ss 17 and 18 cannot apply in a reorganisation, where there is deemed not to be either a disposal or an acquisition. TCGA 1992, s 128(3) deals with the situation where a shareholder receives consideration on a reorganisation apart from the new holding itself. The general rule is that the shareholder is treated as having made a part disposal of the original shares in return for that consideration. This means that the base cost of the original holding is reduced, as for any part-disposal computation, although for all other purposes the no-disposal and composite asset fiction is maintained. TCGA 1992, s 128(4) then tells us that the part-disposal computation must follow the special rule for reorganisations in TCGA 1992, s 129, which covers the method of allocating base cost between the holding deemed to be disposed of and that retained. This may give a different result from the ‘normal’ rule in TCGA 1992, s 42, as demonstrated in Example 6.6 (at 6.28 below). This provision specifically includes within its scope capital distributions within TCGA 1992, s 122. These are any distributions in respect of shares in a company, except distributions on a winding up of a company, that are not new holdings and that are not income for income tax purposes. As we have seen, the disposal of a right under a rights issue is brought into TCGA 1992, s 122 by TCGA 1992, s 123, so TCGA 1992, s 128(3)(a) effectively brings into charge the proceeds of selling the rights to acquire shares under a rights issue. TCGA 1992, s 128(3)(b) also brings into charge any consideration derived (or deemed to be received) from other shareholders in return for the recipient giving up rights in respect of the original holding. We have not seen this in practice but it fits conceptually with the scheme of the legislation, that consideration received in a reorganisation should be taxed.

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Reorganisations of share capital 6.23 TCGA 1992, s 129 – part disposal of new holding, apportionment of consideration 6.22 ‘Subject to section 130(2), where for the purpose of computing the gain or loss accruing to a person from the acquisition and disposal of any part of the new holding it is necessary to apportion the cost of acquisition of any of the original shares between what is disposed of and what is retained, the apportionment shall be made by reference to market value at the date of the disposal (with such adjustment of the market value of any part of the new holding as may be required to offset any liability attaching thereto but forming part of the cost to be apportioned).’ Analysis 6.23 Where any part of a new holding is disposed of or deemed to be disposed of by TCGA 1992, s 128(3), the base cost of the shares or securities comprising the new holding must be properly allocated. The apportionment is made by reference to the market value of the shares or securities at the date of disposal. The HMRC Manual at CG51892 explain that this means that the base cost is apportioned by reference to the market value of the part disposed of divided by the market value of the entire holding. In most cases, the consideration received will represent market value of the part disposed of so that the result is the same as with the application of the normal partdisposal formula of TCGA 1992, s 42. However, Example 6.6 (at 6.28 below) demonstrates the operation of TCGA 1992, s 129 in a situation where the different approaches give different answers. ‘Market value’ for these purposes will be determined in accordance with the normal rules in TCGA 1992, ss 272–274 and Sch 11. This rule applies both to actual disposals of new holdings and to deemed disposals, as under TCGA 1992, s 128(3), for example. As discussed in TCGA 1992, s 128(1), if as part of the reorganisation a liability is disposed of which was part of the original consideration of the old asset, then the consideration for the part disposal, and the base cost of the new asset that represents the remaining value, are adjusted accordingly. Finally, this rule does not apply if the new holding comprises more than one class of share or security and any of those is listed. In any such case, TCGA 1992, s 130 applies instead.

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6.24 Reorganisations of share capital TCGA 1992, s 130 – composite new holdings 6.24 ‘(1) This section shall apply to a new holding – (a) if it consists of more than one class of shares in or debentures of the company and one or more of those classes is of shares or debentures which, at any time not later than the end of the period of 3 months beginning with the date on which the reorganisation took effect, or of such longer period as the Board may by notice allow, had quoted market values on a recognised stock exchange in the United Kingdom or elsewhere, or (b) if it consists of more than one class of rights of unit holders and one or more of those classes is of rights the prices of which were published daily by the managers of the scheme at any time not later than the end of that period of 3 months (or longer if so allowed). (2) Where for the purpose of computing the gain or loss accruing to a person from the acquisition and disposal of the whole or any part of any class of shares or debentures or rights of unit holders forming part of a new holding to which this section applies it is necessary to apportion costs of acquisition between what is disposed of and what is retained, the cost of acquisition of the new holding shall first be apportioned between the entire classes of shares or debentures or rights of which it consists by reference to market value on the first day (whether that day fell before the reorganisation took effect or later) on which market values or prices were quoted or published for the shares, debentures or rights as mentioned in subsection (1)(a) or (1)(b) above (with such adjustment of the market value of any class as may be required to offset any liability attaching thereto but forming part of the cost to be apportioned). (3) For the purposes of this section the day on which a reorganisation involving the allotment of shares or debentures or unit holders’ rights takes effect is the day following the day on which the right to renounce any allotment expires.’ Analysis 6.25 While TCGA 1992, s 129 deals with the general case, this section deals with the special circumstances of a reorganisation where the new holding consists of more than one class of shares or debentures, or more than one class of rights in a unit trust, and one or more of those classes or shares or units are quoted on a recognised stock exchange (in the case of shares or debentures) or have published prices (in the case of units). If those listings occurred within three months of the date of the reorganisation, there are special computational 168

Reorganisations of share capital 6.25 rules for the apportionment of base costs where any part of the new holding is disposed of (or deemed to have been disposed of). The meaning of the phrase ‘more than one class of shares in or debentures of the company’ is not wholly clear in that a reorganisation that produces a new holding consisting of one class of shares and one class of debentures might be said not to comprise ‘more than one class’ of either and the HMRC Manuals do not specifically elucidate this point. However, CG52022 seems to imply that HMRC considers a reorganisation of this kind to be within the terms of TCGA 1992, s 130(1)(a). The legislation tells us to apportion the base cost of the different classes of share, debenture or unit by reference to the market value on the first day on which market values or prices were quoted, whether or not the reorganisation has taken place at that time. Some confusion in construing this provision might arise where a listed company issues, say, some bonus preference shares in a reorganisation. How can the apportionment of the base cost be determined by reference to the first day of listing of the ordinary shares when this was long before the preference shares were issued? The answer lies in the opening words of TCGA 1992, s 130(1): ‘this section shall apply to a new holding …’. So the reference in TCGA 1992, s 130(2) to market value on the first day that prices are quoted refers to the first day that prices are quoted for the new holding. In the scenario above, the HMRC Manual suggests this to mean that the market value to be taken is the price quoted on the first day a price is quoted for the ordinary shares that ‘reflects the effect of the reorganisation’. We agree that this seems a sensible approach. To avoid any debate as to when a reorganisation took place, this is fixed as the day after the right to renounce any allotment expires. As any such reorganisation is likely to take place over a period of time and will encompass a number of events and consequential fluctuations in value, the need for a single moment in time to fix such values is obvious. It is, however, difficult to envisage a situation whereby the shares could be quoted in a way that takes into account the terms of the reorganisation before the date at which the right to renounce any allotment expires, although this seems to be the predicate of CG51995. What is the purpose of this provision? At first glance, it might appear a bit pointless, particularly as there are so many situations when it will not apply, such as a reorganisation of the share capital of a listed company where the new holding only comprises one class of instrument or reorganisations where no shares or debentures are listed until more than three months after the reorganisation has taken place. The HMRC Manual says at CG51976 that the provision ‘gives the shareholder the advantage of knowing the base cost of his or her shares in advance of any disposal. It also avoids some of the 169

6.26 Reorganisations of share capital difficulties with the interaction between the reorganisation provisions and the pooling rules in TCGA92/S104’. These are laudable aims, but they would perhaps be equally valid in the context of all reorganisations, not just those where part of the new holding is listed. For the avoidance of doubt, neither of us knows whether the list price is that at the beginning of trading or the end of trading on the first day, although HMRC instructs inspectors to use the price quoted in Extel. Examples 6.8 and 6.9 (at 6.28 below) illustrate the operation of TCGA 1992, s 130. TCGA 1992, s 131 – indexation allowance 6.26 ‘(1) This section applies where – (a) by virtue of section 127, on a reorganisation the original shares (taken as a single asset) and the new holding (taken as a single asset) fall to be treated as the same asset acquired as the original shares were acquired, and (b) on the reorganisation, a person gives or becomes liable to give any consideration for his new holding or any part of it. (2) Where this section applies, so much of the consideration referred to in subsection (1)(b) above as, on a disposal to which section 53 applies of the new holding, will, by virtue of section 128(1), be treated as having been given for the original shares, shall be treated for the purposes of section 54 as an item of relevant allowable expenditure incurred not at the time the original shares were acquired but at the time the person concerned gave or became liable to give the consideration (and, accordingly, section 54(4) shall not apply in relation to that item of expenditure).’ Analysis 6.27 This section is designed to deal with a problem that would otherwise arise in respect of the system of indexation allowance as applied to the deeming provisions of the reorganisation rules. Indexation allowance, it will be recalled, is designed to prevent the taxation of gains that arise solely as a result of inflation, rather than a genuine increase in value of the asset concerned. The system originally applied to all taxpayers, but indexation allowance was abolished for capital gains tax purposes from 6 April 2008. Indexation allowance for companies was abolished in 2017 and is now only to be calculated to 31 December 2017 by virtue of TCGA 1992, s 53(1B). The policy intention 170

Reorganisations of share capital 6.28 for this was stated to be simplification and aligning the treatment of companies and non-corporate taxpayers as well as the treatment of capital and non-capital assets held by companies. The abolition of indexation allowance might also be due to the record low rate of inflation, such that the perceived benefits of the allowance are outweighed by the compliance burden caused by the complexity of the rules. In the absence of this provision, where new consideration is added to the base cost of an asset under the reorganisation rules, as the new asset is deemed to be the old asset, indexation relief in respect of that part of the base cost that relates to the new consideration would be taken to date back to the time of acquisition of the original asset, rather than to the time at which the new consideration was actually incurred. The section operates by disapplying the rule in TCGA 1992, s 54(4) that would otherwise deem the timing of the commencement of indexation allowance as the time of acquisition of the asset, as the asset concerned in this case is the original asset, by operation of the deeming provisions in TCGA 1992, s 127. Having disapplied the rule in TCGA 1992, s 54(4), the section replaces it with the rules that the indexation allowance should instead run from the time at which the consideration is given or becomes liable to be given. There was no amendment to this provision upon the abolition of indexation allowance for companies from 1 January 2018 as indexation allowance continues to accrue to 31 December 2017 and must be included in chargeable gains computations for assets held at that date.

EXAMPLES 6.28 Now that we have analysed the legislation on reorganisations, we thought that a series of examples might be helpful, to demonstrate the way in which the various elements fit together in some practical situations. Example 6.1 Mr Smith bought 100 £1 shares in Miller Plc in February 2016, paying £5 per share, ie £500. In December 2018 the shares were divided into 10p shares, so Mr Smith now holds 1,000 10p shares in Miller Plc. Analysis: This is a straightforward reorganisation, ie a conversion of the share capital into a different form. TCGA 1992, s 127 operates to treat the new holding of 1,000 10p shares as being the same as the original 100 £1 shares. This means that Mr Smith is treated as having acquired 1,000 10p shares of Miller Plc in February 2016 for £500. 171

6.28 Reorganisations of share capital Example 6.2 Bonus issue Mr Jones bought 40 shares in Hardy Ltd in July 2015, paying £2 per share, ie £80. In October 2017, he receives a bonus issue of 10 shares in Hardy Ltd on a 1-for-4 basis. The result of these transactions is:

July 2015 (original shares) October 2017 bonus issue October 2017 (new holding)

No of shares 40 10 50

Base cost of holding 80 – 80

Analysis: TCGA 1992, s 127 operates to treat the increased new holding as being the same as the original shares. In practice, this means that Mr Jones is treated as having acquired 50 shares of Hardy Ltd for £80 in July 2015. While the shares are likely to have been paid up out of reserves, TCGA 1992, s 128(2)(b) confirms that no account is to be taken of the reserves used to pay up the shares, so that the reserves used are not to be treated, for capital gains purposes, as consideration given for the bonus issue.

Example 6.3 Rights issue Mr Jones bought 40 shares in Hardy Ltd in July 2015, paying £2 per share, i.e. £80. In October 2017, he subscribes £15 for a rights issue of 10 shares in Hardy Ltd on a 1-for-4 basis. The result of these transactions is:

July 2015 (original shares) October 2017 rights issue October 2017 (new holding)

No of shares 40 10 50

Cost of holding 80 15 95

Analysis: TCGA 1992, s 127 operates to treat the increased new holding as being the same as the original shares. TCGA 1992, s 128 will operate to treat the acquisition cost of the holding as including both the original £80 and the subsequent subscription of £15. In practice, this means that Mr Jones is treated as having acquired 50 shares of Hardy Ltd for £95 in July 2015. This can be important for the purposes of business asset disposal relief (formerly known as ‘entrepreneurs’ relief’) and inheritance tax business property relief. 172

Reorganisations of share capital 6.28 Example 6.4 Open offer Mr Smith has an existing holding of 500 shares in Jewitt Ltd acquired for £2,000 in October 2017. In April 2019, Jewitt Ltd issues shares in order to finance the acquisition of Wood Ltd and to fund further working capital. Mr Smith acquires 200 further shares at £5 each. 50 are considered to relate to the open offer element of the transaction, with the balance being in the nature of a vendor placement. Holding 1 – open offer is treated as a reorganisation by RI 74: October 2017 (original shares) April 2019 open offer April 2019 (new holding)

No of shares 500 50 550

Cost £2,000 £250 £2,250

Holding 2 – vendor placement is not a reorganisation: April 2019 vendor placement

150

£750

Analysis: The analysis of the holding acquired in 2017 is the same as for Example 6.3. TCGA 1992, s 127 operates to treat the increased new holding as being the same as the original shares. TCGA 1992, s 128 will operate to treat the acquisition cost of the holding as including both the original £80 and the subsequent subscription of £15. In practice, this means that Mr Smith is treated as having acquired 550 shares of Hardy Ltd for £2,250 in October 2017. The acquisition of the 150 shares deemed to be acquired on the vendor placement is not subject to the reorganisation provisions, so these shares are treated as a separate holding for these purposes. Of course, the combined holding may be subject to the general rules for share pooling (TCGA 1992, ss 104 et seq), but that is outside the scope of this book.

Example 6.5 Reduction of capital Mr Green bought 1,000 redeemable £1 preference shares in Miller Ltd in July 2010, paying £2 per share, ie £2,000. Miller Ltd has a deficit on reserves and in October 2013 the company cancels half the shares for no consideration using the accounting reserve to eliminate the deficit. The result of these transactions is:

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6.28 Reorganisations of share capital No of shares 1,000 –500 500

July 2010 (original shares) October 2013 cancellation October 2013 (new holding)

Cost of holding £2,000 – £2,000

Analysis: On our analysis of TCGA 1992, s 126(3), this transaction does not constitute the redemption of the shares, as the whole of the share capital was not repaid. So, TCGA 1992, s 127 operates to treat the reduced new holding as being the same as the original shares. In practice, this means that Mr Green is treated as having acquired 500 shares of Miller Ltd for £2,000 in July 2010. Example 6.6 Share buy-back Mr Green still holds the 500 remaining shares in Miller Ltd in December 2018. Trade has improved and Miller Ltd decides to reward its loyal shareholders with a share buy-back. The company offers to buy one out of every 10 shares held by shareholders, paying £3 per share, which Mr Green accepts. The market value is £2.50 a share. No of shares 500 –50 450

October 2013 (new holding) December 2018 buy-back December 2018 (new holding)

Cost of holding £2,000 (£150) £1,800

Analysis: TCGA 1992, s 126(3) should not apply as this is not a redemption of the shares, it is a buy-back. On our analysis, a buy-back where the offer is made to all shareholders (or all shareholders of the same class) should be a reorganisation within TCGA 1992, s 126(1). So TCGA 1992, s 127 applies and the December 2018 new holding is treated as having been acquired in July 2010. However, prima facie the consideration of £150 received by Mr Green will be chargeable under TCGA 1992, s 128 (see below).1 The base cost for the purposes of the disposal is given by the special rule in TCGA 1992, s 129 with apportionment according to market value. This is because TCGA 1992, s 129 specifically applies to a new holding, as defined in TCGA 1992, s 127, and the shares held at December 2018 constitute a new holding, because the October 2013 cancellation and the December 2018 buy-back were both reorganisations. 174

Reorganisations of share capital 6.28 In this case, the market value of the shares is £2.50 even though the buyback price is £3.00. TCGA 1992, s 129 tells us the base cost of £2,000 is apportioned by (50 × £2.50)/(500 × £2.50) giving £200. Hence, Mr Green has a capital loss of £50 (£150 − £200) on the transaction and the base cost of his retained holding is reduced by £200 to £1,800. This example demonstrates the difference between the part-disposal rules in TCGA 1992, ss 42 and 129. If the normal rule in TCGA 1992, s 42 had applied, the apportionment of base cost is on the basis of the ratio of the consideration received (which in this example is not the same as market value) to the sum of that consideration and the market value of the retained shareholding. This would give a base cost for the part disposal of £2,000 × (£150/[(450 × £2.50) + £150]) = £235, so the loss would have been £85 and the base cost of the retained shares would have been £1,765. Example 6.7 Reinvestment of dividend Mr West holds 750 shares in Allcock Ltd. In April 2019, the company declares a special dividend of £1 per share and also declares a 1-for-5 rights issue at a price of £1.50 per share. Mr West, who is not a higher rate taxpayer, receives a £750 dividend and decides to invest some of the dividend in the rights issue. The result of these transactions is: No of shares 750 150 900

March 2014 (new holding) April 2019 rights issue April 2019 (new holding)

Cost £1,250 £225 £1,475

Analysis: This example is similar to Example 6.3. TCGA 1992, s 127 operates to treat the increased new holding as being the same as the original shares. TCGA 1992, s 128(1) tells us to add the consideration for the rights issue to the original cost of the shares so that Mr West is treated as having acquired 900 shares of Allcock Ltd for £1,475 in March 2014. TCGA 1992, s 128(2)(b) only applies where the shares are paid up out of ‘any consideration consisting … of any dividend or other distribution declared out of … assets but not made’. In this case, the dividend was paid and Mr West reinvested the dividend into new shares, so TCGA 1992, s 128(2)(b) does not apply. On the basis of this analysis, there is no reason for the company actually to pay the dividend to Mr West. As a matter of administrative convenience, the 175

6.28 Reorganisations of share capital company could have declared the dividend and issued Mr West’s new shares without having to issue him a cheque for the dividend or for him to send the company a cheque for the new subscription. The mechanics of the process are irrelevant so long as legally Mr West received a dividend and reinvested the proceeds.

Example 6.8 Allocation of base cost Mrs Ismail buys 1,000 £1 shares of Amayah Ltd in July 2014 for £3,000 in total. In January 2017, the company splits its capital so that each £1 share is converted into a 10p share and a 90p debenture (not a qualifying corporate bond – see Chapter 8. NB one cannot convert shares into debentures in a single step. A reduction of capital would be needed, and the debentures would be issued in respect of the resultant capital to be repaid). The shares were then listed on the London Stock Exchange. Mrs Ismail’s holding becomes 900 listed 10p shares and 900 90p debentures. On the first day of trading, the shares traded at £5.50. The market value of the debentures was 90p. Analysis: The conversion of share capital is a reorganisation within TCGA 1992, s 126(1), so the new holding of 1,000 10p shares and 1,000 90p debentures is treated as having been acquired in July 2014 for a total of £3,000. Since the new holding consists of more than one class of shares or debentures (accepting HMRC’s published view at CG52022) and the new shares were listed within three months of the reorganisation, TCGA 1992, s 130(2) operates to fix the apportionment of the £3,000 base cost between the shares and the debentures. Since the shares have a market value of £5.50 and the debentures have a market value of 90p, the base cost is apportioned on the basis of 550:90, so that Mrs Ismail’s base cost in the shares is deemed to be £2,578 and her base cost in the debentures is £422. Example 6.9 Allocation of base cost Mr Davies buys 5,000 £1 shares of Turner plc, a UK listed company, in August 2016 for £12,000. In June 2019, the company declared its intention to issue bonus fixed rate £1 preference shares on a 1-for-10 basis. The right to renounce the allotment expired on 30 June 2004 and the preference shares were issued on 10 August 2019.

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Reorganisations of share capital 6.28 The ordinary shares had an Extel price of £6.60 on 1 July and £6.50 on 10 August 2019. The preference shares are valued at £1.04 when issued. The value of the right to receive those shares is given as £1.02 on 1 July 2019. Analysis: The bonus issue of preference shares is a reorganisation within TCGA 1992, s 126(2)(a), so the new holding of 5,000 £1 shares and 500 preference shares is treated as having been acquired in August 2016 for £12,000. The new holding comprises both the original ordinary shares and the new preference shares. Since the new holding consists of more than one class of share and the ordinary shares continued to be listed, TCGA 1992, s 130(2) operates to fix the apportionment of the £12,000 base cost between the shares and the debentures. The basis of the apportionment is market value when the shares were first quoted at a price reflecting the reorganisation (see the analysis of TCGA 1992, s 130(2) above). There is no real guidance on when this should be. One approach might be to assume this to be the day after the right to renounce allotments of preferences expired, being the statutory date the reorganisation is deemed to have taken effect. In that case, the ordinary shares have a market value of £6.60, but the debentures have not been issued yet. Logic suggests that we take the value of the right to receive them, being £1.02, in which case the base cost is apportioned on the basis of 660:102, so that Mr Davies’ base cost in the ordinary shares is deemed to be £10,394 and his base cost in the preference shares is £1,606. If it were held that the effective listing date for the new holding was the day the preference shares were actually issued, the apportionment would be on the basis of the market values on 10 August 2019, being 650:104. The base cost in the ordinary shares would then be £10,344 and her base cost in the preference shares is £1,656. Comment: This example demonstrates some of the practical difficulties in the application of TCGA 1992, s 130. Perhaps an apportionment of base cost on the basis of market value at the time of disposal, the normal TCGA 1992, s 129 rule, might be less confusing after all.

1 In this case the amounts being repaid are less than the nominal value of the shares, so there is no need to consider the distributions legislation: ICTA 1988, s 209(2)(b).

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6.29 Reorganisations of share capital

CAPITAL REDUCTIONS AND THEIR INTERACTION WITH DISTRIBUTIONS 6.29 As we have already seen, the reorganisation provisions specify that where value passes out of a company in the context of a reorganisation a part disposal of the existing holding is deemed to be made by TCGA 1992, s 128. Adjustments are made to the base cost of the remaining holding. The mechanism for the taxation of such a part disposal is provided by both TCGA 1992, ss 42 and 128. In the event that shares are not cancelled or repurchased so that no actual disposal is being made, then a disposal can be deemed to occur under TCGA 1992, s 122. However, tax is also charged on distributions of value from a company, under ITTOIA 2005, s 383 for income tax purposes and under CTA 2009, Part 9A for corporation tax. So how do these apparently overlapping regimes interact? The interaction of these various provisions can be complex, so it is worth drawing back and understanding the policy behind these contrasting legislative mechanisms. The starting point is the basic premise that where value is being extracted from a company in the context of a reorganisation, the fact that value is now in the hands of the shareholder means that prima facie some form of tax charge should be crystallised in the hands of the shareholder. If a disposal has been made, then general capital gains principles should apply to tax any resulting gain. If no actual disposal has been made, then if the receipt is of a capital nature, a mechanism is required to deem a disposal to have been made to enable the capital gains rules to apply to tax the amount received by the shareholder. Hence the need for TCGA 1992, s 122 which deems such a disposal to have been made. However, it is also possible that the receipt is of an income, rather than a capital, nature. For example, if shares are cancelled for a consideration that exceeds the amount originally subscribed for them, CTA 2010, s 1000(1)B deems the excess to be an income distribution and an individual would be taxed accordingly. Where the income distribution rules apply, TCGA 1992, s 122 expressly does not apply to distributions of an income nature so avoiding a double charge to tax. In any case, TCGA 1992, s 37 would also probably prevent double taxation. Companies are now subject to a tax charge on distributions received, under CTA 2009, Part 9A. However, in most cases, the distribution will not actually be chargeable, as the effect of CTA 2009, Part 9A is to exempt almost all distributions received by a company. In such cases, the distribution is also not

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Reorganisations of share capital 6.29 chargeable under TCGA 1992, s 122, as this is prevented by the operation of TCGA 1992, s 122(6) (enacted in F(No 3)A 2010). However, CTA 2009, s 931RA states that ‘The fact that a dividend or other distribution is exempt [by the operation of Part 9A] does not prevent it from being taken into account in the calculation of chargeable gains’. This means that, although an exempt distribution cannot be charged to corporation tax on chargeable gains by TCGA 1992, s 122, it can be part of the computation of a chargeable gain under general principles. This follows the decision of Strand Futures and Options Ltd v Vojak 76 TC 220. In that case, Strand Futures and Options Ltd (‘SFOL’) held 29.9 per cent of the shares of another company, City of London Options Ltd (‘CLO’). As part of a disposal strategy, SFOL agreed to sell half the shareholding to a third party and the other half was to be repurchased by CLO at market value (see Figure 6.11). The market value price represented a premium to SFOL’s acquisition cost. The premium was not taxable as an income distribution, because of the exemption then in ICTA 1988, s 208 (now wholly repealed). The Revenue therefore charged the consideration to capital gains tax (in line with its published view on this point in Statement of Practice 4/1989), but SFOL argued that ICTA 1988, s 208 also operated to exempt the premium from tax as a capital gain. Figure 6.11 Strand Fixtures & Options Ltd v Vojak

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6.30 Reorganisations of share capital The Court of Appeal found for the Revenue that corporation tax on chargeable gains was due in respect of the consideration received by SFOL for the cancellation of CLO’s shares, on the basis that there was a natural disposal of the shares of CLO and there was no reason in policy or legislation why the disposal should not be charged to tax in the normal way. Furthermore, there was clearly no element of double taxation, as the premium was not taxed as an income distribution. The practical consequence of the decision of the Court of Appeal in this case is that, as described in SP 4/89, a gain on such a repurchase of shares is taxable in the hands of a corporate shareholder, which is now made explicit by CTA 2009, s 931RA. The wider implications for the understanding of the tax code is in the fact that the High Court found for the company on the basis of an apparent anomaly elsewhere in the tax code, which led the judge to review the coherence of the tax system as a whole and, in particular, the history of ICTA 1988, s 208. However, in the final analysis, although the legislative history of a provision may be relevant in considering its construction at a later date, this earlier history of a provision should be properly understood in the context of the tax code and the surrounding legal and commercial environments as they existed at that earlier time. Furthermore, it is not always possible to interpret any given provision in a way that resolves all possible anomalies with the rest of the tax code. It is an unfortunate by-product of the way the UK tax code has arisen that such anomalies do exist and it is not up to the courts to resolve all possible difficulties when looking at the interpretation of a single provision. Indeed, were such an apparent anomaly to be subjected to more detailed scrutiny in relation to a relevant case, it may well be the case that the practical implications of the apparent anomaly would be more adequately explained and the apparent difficulties resolved.

CONCLUSION 6.30 In this chapter, we have seen how the commercial concepts of a reorganisation of share capital have been enacted into tax legislation to give effect to Parliament’s intention to exempt reorganisations from the normal rules on a disposal. This intention has been implemented by the no-disposal fiction, while the tax base has been preserved by the composite asset fiction for the purposes of ensuring that the ultimate disposal of an asset – other than by way of a reorganisation – is fully taxable by reference to the cost and holding period relating to the acquisition of the original shares. We have also looked briefly at the interaction of the concepts of reorganisation and reduction of capital with the distributions legislation and seen how the courts have, where necessary, considered the legislative history of the relevant

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Reorganisations of share capital 6.31 provisions. Where they have done so, they have considered it appropriate to look at the wider legal and commercial environment too in order to interpret the earlier form of the legislation in a proper context.

STAMP TAXES AND REORGANISATIONS 6.31 In reorganisations of capital as defined above, existing securities may be cancelled, reclassified, combined or divided and new securities may be issued, whether or not for consideration payable by the shareholder. However, no value passes out of the company to shareholders. Such a reorganisation does not normally involve any transfer of securities for consideration. The issue of new shares, as opposed to the transfer of previously issued shares, does not give rise to stamp duty charges unless, exceptionally, the shares are issued in bearer form. However, provisions for the abolition of bearer shares in Small Business, Enterprise and Employment Act 2015, s 84 came into effect on 26 May 2015. In summary, they prohibit UK companies from issuing any further bearer shares and, within nine months of that date, all existing bearer shares must be surrendered, becoming registered shares. Equally the redemption of redeemable securities, whether for cash or out of the proceeds of the issue of further securities made for the purpose, where value may pass out of the company, does not involve any transfer. None of these transactions give rise to stamp duty charges. Where these transactions lead to a change in the relative rights of shareholders, it will be necessary to consider whether this has any effect on previous SDLT claims made by the company or group, as explained in Chapter 2. The repurchase of shares by a company under Companies Act 2006, Chapter 4 does not normally require a formal transfer, but in this specific case the return to Companies House under Companies Act 2006, s 707 is treated as a transfer on which stamp duty arises (FA 1986, s 66), payable by the company. Documenting a simple reorganisation as a repurchase of shares, albeit paid for by the issue of other securities, would therefore give rise to an unnecessary stamp duty charge. However, if the shares are repurchased from another company in the same 75 per cent worldwide corporate group, it will normally be possible to claim group relief from stamp duty as explained in Chapter 2. An alternative to the repurchase of shares may be a reduction of capital by way of a solvency statement or a court-approved reduction of share capital, followed by distribution of the reserves thus created. This should not normally give rise to stamp duty charges, but in the case of a court-approved reduction the courts are unlikely to sanction such a reduction if the only reason for taking that route rather than the repurchase route is to save stamp tax!

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6.32 Reorganisations of share capital Stamp duty will not arise on bonus and rights issues, placements and open offers, if the new shares are issued directly to the shareholder or to a broker or other market professional who receives them as nominee for identified shareholders. However, if the company issues the shares beneficially to a broker underwriting the issue, a stamp duty charge will arise on the onward placement or transfer. The exception to this rule occurs when the shares are part of a public issue conditional on a stock market listing. In this case the onward sale of shares by the underwriter will not be subject to SDRT (FA 1986,s 89A). There is no equivalent relief from stamp duty, but such public issues invariably proceed by electronic transfer so no stamp duty charges would arise. When a holding of shares changes hands, the stamp duty is normally paid by the purchaser of those shares, based on the consideration paid. The history of a holding of shares, in terms of any reorganisations which may have taken place in the past, is not relevant.

VALUE ADDED TAX 6.32 The transactions dealt with in this chapter never themselves give rise to output VAT. The question that arises in practice is whether a party who incurs standard-rated costs in relation to the exercise (normally professional fees) is entitled to a refund of the input VAT on them.

The position of the shareholder 6.33 Often the shareholder will run up no incidental costs. Where he does the first question is always whether he is carrying on a business for VAT purposes which involves the holding of the shares. This is dealt with at 3.6 above. If he is not he cannot, of course, obtain a refund of any input VAT. If he is carrying on a relevant business the transaction will, in the great majority of cases, involve no supply for VAT purposes by him. In the case of a bonus or rights issue, for example, he is making an acquisition, not a disposal. In the case of a variation of share rights almost always, in our view, he is likewise making no supply. Any input VAT which he incurs on incidental costs should relate to his continuing business, or the relevant part of it: for example if he is rendering (standard-rated) management services to the company, the exercise will be carried out for the purpose of that continuing business of his, and so the input VAT will be fully recoverable. In some other cases, for example where the shareholding is a trade investment, see 3.6 above, the input VAT is likely to be residual. Where there is a rights issue but the shareholder does not take up his rights and they are sold on his behalf and he receives some cash for them, that will almost 182

Reorganisations of share capital 6.34 always be an exempt supply by him. His only sales proceeds, and the only thing to be added to box 6 of his return, are the price received for the rights. It does not follow that any input VAT run up on incidental costs is run up wholly for the purpose of selling that rights entitlement. Ordinarily, in our view, it would be run up at least in part for the purpose of the shareholder’s continuing business and he should make the appropriate input VAT reclaim. See further on this at 8.24 below. In the case of a reduction of share capital, the shareholder will ordinarily receive some cash from the company, and sometimes it may be accompanied by a cancellation of some of his shares. In our view a simple reduction of capital does not involve any exempt or other supply by the shareholder to the company. The amount which he receives is akin to the receipt of a dividend or distribution on a winding up: these are fruits of his investment in the company, not consideration for any supply by the shareholder to the company and are outside the scope of VAT: Skatteverket v AB SKF [2010] STC 419, ECJ and earlier cases. (For more complicated reductions used to effect a reconstruction, see 25.28 below.) The position as regards any input VAT incurred by him on incidental expenses is the same as in the case of a bonus issue, see above.

Position of the company 6.34 Again, the first question is whether the company is carrying on a relevant business. If it is a pure passive holding company, see 3.6 above, it cannot be entitled to a refund of any input VAT, unless possibly it is VAT-grouped with one or more companies carrying on a taxable business. A company which is carrying on a business and which issues shares whether by bonus, rights, or in any other way makes no supply: Kretztechnik AG v Finanzamt Linz [2005] STC 1118, ECJ, further explored in 8.26 below. A fortiori it makes no supply when it varies its share rights or reduces its capital. Any input VAT it incurs in connection with the exercise should be incurred for the purpose of its continuing business and will normally be residual: VAT Regulations 1995, SI 1995/2518, reg 101.

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Chapter 7

Conversions of securities

INTRODUCTION 7.1 In this chapter, we will be looking at the application of the reorganisations provisions to the conversion of securities either into other securities or into shares. Many of these provisions have been part of the capital gains legislation since the original short-term gains legislation was enacted in 1962, so their importance has always been considered fundamental to the proper operation of this tax. The original wording in FA 1962, Sch 7, para 11(1) was: ‘Subject to sub-paragraph (2) below, paragraph 10 above [now TCGA 1992, ss 126 et seq] shall apply with necessary adaptations in relation to the conversion of securities as it applies in relation to the reorganisation or reduction of a company’s share capital.’ While the words have been modified over the intervening 57 or so years to keep pace with commercial and legal changes, to fit with amended or consolidated legislation or to prevent tax avoidance, the basic core of the legislative provisions has remained unchanged. Again, there is no assistance from the Notes on Clauses for these exceptions to the general rules on disposals, but arguably the same logic applies as it does to ordinary reorganisations; that the person has not made a real disposal, merely converted one form of security into another, so that the disposal has not generated any cash to permit a tax liability to be paid. As always, the question can be put the other way: ‘why would Parliament wish to tax such a transaction?’ The ability for a company to convert its capital base from one form into another is an important part of normal commercial activity and it clearly makes sense to ensure that the tax system does not distort this sort of commercial decision making.

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Conversions of securities 7.2

DEFINITION OF ‘SECURITY’ 7.2 This is an extraordinarily complex area and the best that can be said for the combined forensic talents of judges and commentators alike is that there is no general agreement on the meaning of ‘security’. Perhaps the only agreement is that there is no general definition that fits all parts of the Taxes Acts (or, indeed, the wider company legislation). There is no definition of ‘security’ anywhere in the Taxes Acts other than definitions that specifically include certain things within the scope of ‘securities’ for a particular purpose, presumably because there was originally some doubt as to whether those items would otherwise rank as securities. For example, the definition of a ‘security’ for the purposes of TCGA 1992, ss 132 and 133 (and TCGA 1992, s 251) is contained in TCGA 1992, s 132(3)(b) and ‘includes any loan stock or similar security whether of the government of the United Kingdom or of any other government, or of any public or local authority in the United Kingdom or elsewhere, or of any company, and whether secured or unsecured’. The definition of ‘debenture’, at Companies Act 2006, s 738, tells us that ‘“debenture” includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not’. There is a clear implication that a debenture for the purposes of the Companies Act is a security and that all securities are debentures, which is all a bit circular and suggests that there is no real distinction between the two terms. However, HMRC’s view has generally been that ‘not all debentures will be securities. A security is more than an acknowledgement of indebtedness by a company’1. Although the context was taper relief, the statement is a general one about the meaning of ‘debenture’ and not restricted to any special taper relief definition. The current HMRC guidance on share exchanges (see Chapter 8) at CG52540 also implies that debentures and securities need not always be the same: ‘Nearly all debentures issued in exchange for shares and debentures will be securities within the meaning of TCGA92/S132 (3)(b)’. Similarly, TCGA 1992, s 132(3)(a) refers to ‘any debenture which is not a security’, as does TCGA 1992, s 132(5), so the draftsman presumably also agrees with HMRC’s view on this point. Furthermore, there appears to be no requirement that a security be secured on anything, as a security does not have to constitute a charge on the assets of the company (see above, regarding CA 2006, s 738). Consistent with this, TCGA 1992, s 132(3)(b) tells us that a security includes various instruments ‘… whether secured or unsecured’. The majority of case law in this area has concentrated on the meaning of the phrase ‘debt on a security’, which currently appears in TCGA 1992, s 251, as 185

7.2 Conversions of securities ‘the debt on a security (as defined in section 132)’. This is unhelpful as the phrase ‘debt on a security’ is not defined in TCGA 1992, s 132 and nor in truth is ‘security’. The word has also been discussed at great length in a number of cases. The leading case on the meaning of securities is Williams v Singer [1921] 1 AC 65. This case considered income tax on dividends of shares of a foreign corporation, under the legislation then contained in Income Tax Act 1842 and FA 1914. Here, Viscount Cave said: ‘My Lords, the normal meaning of the word “securities” is not open to doubt. The word denotes a debt or claim, the payment of which is in some way secured. The security would generally consist of a right to resort to some fund or property for payment, but I am not prepared to say that other forms of security (such as personal guarantee) are excluded. In each case, however, where the word is used in its normal sense, some form of secured liability is postulated.’ In the same case, Lord Shaw of Dunfermline said: ‘The word “securities” has no legal signification which necessarily attaches to it on all occasions of the use of the term. It is an ordinary English word used in a variety of collocations, and it is to be interpreted without the embarrassment of a legal definition and simply according to the best conclusion one can make as to the real meanings of the term as it is employed in, say, a testament, an agreement, or a taxing or other statute as the case may be. The attempt to transfer legal definitions derived from one collocation to another leads to confusion and sometimes to a defeat of true intention.’ Both of these obiter remarks suggest that we should look for a plain English meaning of the word ‘security’, albeit a meaning that is relevant to the context. The Oxford English Dictionary gives us ‘a document held by a creditor as guarantee of his or her right to payment; a certificate attesting ownership of stock, shares, etc; the financial asset represented by such a document’. So there is a suggestion that a security must be a document of some sort and that, in the current context at least, the document in some way evidences a debt. However, there is no requirement that the debt be secured in any way on the assets of the borrower – the document itself is capable of being security enough. In IRC v Parker 43 TC 396, the definition of securities was considered in the High Court. Ungoed-Thomas J reviewed a number of tax cases concerning securities and concluded that: ‘(1) prima facie, security is limited to security for the payment of a debt as contrasted with shares in the capital of a company; 186

Conversions of securities 7.3 (2) the context may extend its meaning to include shares [as it was in the context of that case]; (3) security by a document establishing personal liability and without charge on property is recognised as a form of security; (4) it is questionable whether security in that sense would be within its prima facie meaning; but (5) even if it is not within the prima facie meaning of security, yet such security is a less extended meaning of that word than is “share”.’ The debenture issued was held to be a security within the meaning of ‘transaction in securities’. While acknowledging that this case was on a different subject and was concerned with tax avoidance, the similarity of the wording leads to it being a leading contender with Williams v Singer for trying to understand what is meant by ‘security’. For our purposes, it is probably sufficient to assume that any debt instrument issued by a company is a security. While this may not technically be true in every case, we have never seen the point challenged in the normal commercial context, by HMRC or by taxpayers. This is consistent with the approach taken by HMRC in their Capital Gains Manual at CG50220 which states, in the context of TCGA 1992, s 132, that ‘Here the word “security” is used in its narrower sense of loan capital’.

1 Originally in Inland Revenue’s article ‘Taper Relief: Meaning of “Security”’ in Tax Bulletin 53. This was superseded by CG17930, which is no longer included in HMRC’s Manuals since the repeal of taper relief in FA 2008.

THE LEGISLATION TCGA 1992, s 132(1) and (2) – conversion of securities treated as reorganisation 7.3 ‘(1) Sections 127 to 131 shall apply with any necessary adaptations in relation to the conversion of securities as they apply in relation to a reorganisation (that is to say, a reorganisation or reduction of a company’s share capital). (2) This section has effect subject to sections 133 and 134.’

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7.4 Conversions of securities Analysis 7.4 TCGA 1992, s 132(1) introduces the concept that a conversion of securities should be treated as a reorganisation for tax purposes. It permits ‘necessary adaptations’ to the terms of TCGA 1992, ss 127–131 in order to achieve this aim without prescribing what those necessary adaptations should be, which gives both taxpayers and HMRC a degree of flexibility to operate a common sense approach to this legislation. This deemed equivalence to a reorganisation of share capital tells us that the securities held before the conversion should be treated as if they were the ‘original shares’ in TCGA 1992, s 127 and the securities held after the conversion should be treated as the ‘new holding’. Therefore, the converted securities are treated for capital gains purposes as having been acquired at the same time and at the same cost as the original securities. TCGA 1992, ss 133 and 134 introduce some provisions specific to the conversion of securities, dealing with premiums on conversion and with compensation stock respectively. These are discussed below. TCGA 1992, s 132(3) – definition of ‘security’ and of ‘conversion of securities’ 7.5 ‘(3) For the purposes of this section and section 133 – (a) “conversion of securities” includes any of the following, whether effected by a transaction or occurring in consequence of the operation of the terms of any security or of any debenture which is not a security, that is to say – (i)

conversion of securities of a company into shares in the company, and

(ia) a conversion of a security which is not a qualifying corporate bond into a security of the same company which is such a bond, and (ib) a conversion of a qualifying corporate bond into a security which is a security of the same company but is not such a bond, and (ii) a conversion at the option of the holder of the securities converted as an alternative to the redemption of those securities for cash, and

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Conversions of securities 7.6 (iii) any exchange of securities effected in pursuance of any enactment (including an enactment passed after this Act) which provides for the compulsory acquisition of any shares or securities and the issue of securities or other securities instead, (b) “security” includes any loan stock or similar security whether of the government of the United Kingdom or of any other government, or of any public or local authority in the United Kingdom or elsewhere, or of any company, and whether secured or unsecured.’

Analysis 7.6 TCGA 1992, s 132(3) describes the various conversions that are within the scope of TCGA 1992, s 132. The original list – in 1962 – included only TCGA 1992, s 132(3)(a)(i) and (ii) – although TCGA 1992, s 132(3)(a)(iii) appeared in the capital gains tax legislation in FA 1965, Sch 7 – so the list has become longer and more complex over the years as commercial practice has developed, generating different types of security, and also as tax legislation has changed, so that certain types of security have had their tax characteristics altered by legislation without the terms of the security itself being subjected to any change. An example of this is the concept of the qualifying corporate bond (‘QCB’) with its own specific tax treatment under the loan relationships legislation (CTA 2009, Part 5), so that it is outside the scope of capital gains tax (this is an important area and is discussed in Part 3 of this book). It is important to remember, however, that this list is non-exhaustive. The opening phrase is ‘“conversion of securities” includes any of the following’, so the listed conversions are specifically brought within the scope of the provisions, just in case they do not naturally fall to be treated as conversions of securities. But any conversion of a security, regardless of whether it falls into the list, is within the scope of these provisions. TCGA 1992, s 132(3)(a)(ia) and (ib) are really only ‘gateway’ provisions. The conversions of a non-QCB into a QCB or vice versa are dealt with by TCGA 1992, s 116 (see Chapter 8), but a transaction only gets into TCGA 1992, s 116 by being a transaction to which TCGA 1992, s 135 would otherwise apply. So TCGA 1992, s 132(3)(a)(ia) and (ib) operate to deem the conversions to be within TCGA 1992, s 135 so that TCGA 1992, s 116 can then apply. Convoluted, perhaps, but it seems to work. Finally, TCGA 1992, s 132(3)(a)(iii) is a provision that would, inter alia, apply where there is a compulsory acquisition of shares or securities and an issue of securities in exchange. This is a rare event these days but was more relevant when an industry or business was taken into public ownership

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7.6 Conversions of securities (such as nationalisation of an industry) and the shareholders were given Government bonds in exchange, referred to as ‘compensation stock’. Where the bonds given in exchange are gilt-edged securities, however, TCGA 1992, s 134 applies instead of TCGA 1992, s 132. The conversion of one class of share for another class of share in the same company does not come within the terms of the section as there is nothing in TCGA 1992, s 132 to treat ‘security’ as including share for the purposes of this provision. Indeed, the reference in TCGA 1992, s 132(2)(a)(i) to ‘conversion of securities of a company into shares in the company’ suggests that the conversion of one class of share for another class of share in the same company was not intended to fall within TCGA 1992, s 132 as a conversion of securities. In any case, a conversion of share capital would fall within TCGA 1992, s 126 and be treated as a reorganisation by those provisions. The words ‘whether effected by a transaction or occurring in consequence of the operation of the terms of any security or of any debenture which is not a security’ arose from the case of Harding v HMRC SpC 608, [2008] All ER (D) 265 and [2008] EWCA Civ 1164. Mr Harding purported to have a security that changed its status without a transaction, by the use of a clause that expired after a set period of time. As a result, he claimed that the redemption of the bond escaped taxation altogether. HMRC won the case at every stage but evidently found the issue sufficiently important that they added the concept of a conversion without a transaction to the scope of TCGA 1992, ss 132 and 116, just in case. This case is discussed in more detail in Chapter 9. In a more recent First-Tier Tribunal case, Klincke v HMRC [2010] STC 2032, Mr Klincke arranged for an extraordinary resolution to amend the terms of his non-QCB loan notes, so that they were subsequently QCBs. However, he argued that this did not amount to a ‘conversion’, so that TCGA 1992, s 132 was not in point. The Tribunal Judges gave the argument short shrift, saying: ‘Our conclusion is based on the plain wording of the CGT code. On that basis we have concluded in favour of HMRC that the events of 17 October 1995 amounted to a conversion of Mr Klincke’s loan notes with the result that the latent chargeable gains were crystallised at that moment.’ Example 7.1 Miss French loaned Surtees Ltd £3,000 in February 2015 receiving a fixed-rate loan note paying interest at LIBOR plus 1%. This was not a QCB. In April 2016, Miss French agreed to convert the loan note to a fixed interest rate of 5.25% on terms such that the loan note is still not a QCB.

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Conversions of securities 7.8 Analysis: This conversion is a conversion of a security within TCGA 1992, s 132(1) so we do not need to turn to any of the special cases of TCGA 1992, s 132(3). TCGA 1992, s 132(1) deems the conversion to be a reorganisation within TCGA 1992, s 127 so the original floating-rate loan note is the ‘original shares’ and the fixed interest loan note is the ‘new holding’. The legislation therefore deems the fixed interest loan note to have been acquired in February 2015 for £3,000. TCGA 1992, s 132(4) and (5) – further definitions 7.7 ‘(4) In subsection (3)(a)(ia) above the reference to the conversion of a security of a company into a qualifying corporate bond includes a reference to – (a) any such conversion of a debenture of that company that is deemed to be a security for the purposes of section 251 as produces a security of that company which is a qualifying corporate bond, and (b) any such conversion of a security of that company, or of a debenture that is deemed to be a security for those purposes, as produces a debenture of that company which, when deemed to be a security for those purposes, is such a bond. (5) In subsection (3)(a)(ib) above the reference to the conversion of a qualifying corporate bond into a security of the same company which is not such a bond includes a reference to any conversion of a qualifying corporate bond which produces a debenture which – (a) is not a security, and (b) when deemed to be a security for the purposes of section 251, is not such a bond.’ Analysis 7.8 TCGA 1992, s 251(6) deems certain debentures, issued on or after 16 March 1993, to be securities for the purposes of that section. Conversion of any such debentures into QCBs is brought within TCGA 1992, s 132(3)(a)(ia) by TCGA 1992, s 132(4). Without this provision, if those debentures were not also securities, TCGA 1992, s 132 would not be capable of applying to any conversion of those debentures into securities.

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7.9 Conversions of securities The debentures to which this applies are: ●●

debentures issued on a reorganisation to which TCGA 1992, s 126 applies or in pursuance of an allotment on such a reorganisation;

●●

debentures issued in exchange for shares or debentures of another company in a case to which TCGA 1992, s 135 applies (see Chapter 8);

●●

debentures issued on a reconstruction to which TCGA 1992, s 136 applies (see Chapter 15);

●●

debentures issued in pursuance of rights attached to a debenture issued on or after 16 March 1993 which itself is within any of the categories above.

Similarly, TCGA 1992, s 251(6) also tells us that ‘any debenture which results from a conversion of securities within the meaning of section 132, or is issued in pursuance of rights attached to such a debenture, shall be deemed for the purposes of [section 251] to be a security (as defined in that section)’. So if a security is converted to a debenture that is not a security, TCGA 1992, s 251 deems the issued debenture to be a security. TCGA 1992, s 132(5) is the other side of that deeming provision and ensures that the conversion of a security that is a QCB into a non-security debenture will be treated as a reorganisation as if it were a conversion of a security into another security. There appears to be a lacuna here in that there is no provision for the reorganisation treatment to apply on the conversion of a non-QCB security to a non-security debenture. TCGA 1992, s 133 – premiums on conversion of securities 7.9 ‘(1) This section applies where, on a conversion of securities, a person receives, or becomes entitled to receive, any sum of money (“the premium”) which is by way of consideration (in addition to his new holding) for the disposal of his converted securities. (2) If the premium is small, as compared with the value of the converted securities – (a) receipt of the premium shall not be treated for the purposes of this Act as a disposal of part of the converted securities, and (b) the premium shall be deducted from any expenditure allowable under this Act as a deduction in computing a gain or loss on the

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Conversions of securities 7.10 disposal of the new holding by the person receiving or becoming entitled to receive the premium. (3) [Repealed] (4) Where the allowable expenditure is less than the premium (or is nil) – (a) subsection (2) above shall not apply, and (b) if the recipient so elects (and there is any allowable expenditure) – (i)

the amount of the premium shall be reduced by the amount of the allowable expenditure, and

(ii) none of the expenditure shall be allowable as a deduction in computing a gain accruing on the occasion of the conversion, or on any subsequent occasion. (5) In subsection (4) above, “allowable expenditure” means expenditure which immediately before the conversion was attributable to the converted securities under paragraphs (a) and (b) of section 38(1).’ Analysis 7.10 This provision covers certain cases where a premium is received on conversion of securities. The normal case, of course, would be to tax the premium as a part disposal of the securities under TCGA 1992, s 128 (with any ‘necessary adaptations’ per TCGA 1992, s 132(1)). However, TCGA 1992, s 133 offers an alternative when the premium received is small when compared to the value of the securities. We believe from the words of the legislation that the comparison here must be made against the value of the securities before conversion, as TCGA 1992, s 133(1) refers to the premium as being ‘for the disposal of his converted securities’, ie for the disposal of the securities that are then converted into something else. Under this alternative, instead of charging tax as if the premium arose on a part disposal of the securities, the premium is to be deducted from the base cost of the converted securities. Thus, the gain on an eventual disposal of the securities will be increased by the amount of the premium. This treatment is mandatory and its purpose is stated (in RI 164) to be ‘to avoid the delay and expense of a full computation where this would be disproportionate and to avoid the need for assessments in trivial cases’. This does, of course, beg the question as to why there is no such provision in TCGA 1992, s 128 as well, since this approach is used in a number of other places in the Act (TCGA 1992, ss 23, 116, 122 and 243).

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7.10 Conversions of securities Where the premium exceeds the allowable expenditure (ie the base cost), this provision does not apply so the premium would be charged to tax under TCGA 1992, s 128 in the normal way. However, the recipient can elect that only the excess of the premium over base cost is to be charged under TCGA 1992, s 128. If this election is made, then no base cost of the securities is available to set against the proceeds of any subsequent disposal. The meaning of ‘small’ in this context was left undefined by the legislators. There is jurisprudence in O’Rourke v Binks 65 TC 165, which is the seminal case in this area, and which determined that the question is one of fact and degree and has to be considered in the light of the circumstances in each case. For most cases, HMRC will accept that ‘small’, for these purposes, means less than 5% of the value or less than £3,000, even if that exceeds 5% of the value of the securities. There is guidance on this in the HMRC Capital Gains Manual at CG57936 and in RI 164 (February 1997). Both the Manual and RI 164 note, however, that there may be cases where a premium in excess of 5% of the value of the securities should be treated as being small or where a premium of less than 5% should not be treated as small. These cases will be decided on their merits, but are, in any event, likely to be rare. Example 7.2 Miss French still held the fixed interest loan note in Surtees Ltd by May 2017 when the company agreed to reconvert the loan note to one carrying interest at LIBOR plus 1% as trading had picked up considerably. Again, this is not a QCB. As a reward to loyal lenders, the company also agreed to pay loan note holders a premium of £500. Analysis: This is again a conversion of a security within TCGA 1992, s 132(1) and deemed to be a reorganisation within TCGA 1992, s 127, so now the fixed interest loan note is the ‘original shares’ and the floating rate loan note is the ‘new holding’ and the legislation therefore deems the fixed interest loan note to have been acquired in February 2015 for £3,000. The normal case is that the premium would be taxed as a part disposal under TCGA 1992, s 128(3). Here, however, the premium is less than £3,000, so should be treated as ‘small’ and within TCGA 1992, s 133 (at least for the purposes of the example). The premium is therefore not treated as a disposal of the securities – TCGA 1992, s 133(2)(a) – and is instead deducted from the original base cost – TCGA 1992, s 133(2)(b). As a result, the loan note is now treated as having been acquired in February 2015 for £2,500.

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Conversions of securities 7.10 Example 7.3 Mr McFadden bought listed non-QCB securities for £1,000 in April 2015. In October that year, the company decided to capitalise some of its debt and to convert the securities into shares. As an incentive to shareholders, the company also agreed to pay a premium and Mr McFadden received £1,200. At the date of conversion, the market value of the shares was £1,050. Analysis: This is a conversion of a security within TCGA 1992, s 132(3)(a)(i) and deemed to be a reorganisation within TCGA 1992, s 127, so the loan note is the ‘original shares’ and the shares are the ‘new holding’. Prima facie, the shares are deemed to have been acquired and the legislation therefore deems the fixed interest loan note to have been acquired for £1,000 in April 2015. However, we must also consider the premium. This is less than £3,000, so should be treated as ‘small’ and within TCGA 1992, s 133. In this case, however, the premium also exceeds the original cost of the securities, so TCGA 1992, s 133(4) disapplies s 133(2) and the premium is, after all, charged to tax as a part disposal of the securities by TCGA 1992, s 128(3). The apportionment of the original expenditure in either case is based on TCGA 1992, s 129 by virtue of s 128(4). On this basis, the £1,000 cost is apportioned on the basis of £1,200:£1,050, so the £1,200 premium is associated with £533 of allowable expenditure, giving a gain of £667. The shares have a base cost of £467 for future disposals. However, Mr McFadden can elect under TCGA 1992, s 133(4)(b) to reduce the premium by the base cost of the shares, so that only £500 premium is chargeable under TCGA 1992, s 128(3) as a £500 gain. In this case, the allowable expenditure in respect of the eventual disposal of the securities is reduced to nil. The interesting question that arises from this example is whether a premium on conversion of a security should ever really be considered to be ‘small’ if it exceeds the original cost of the securities. Clearly, this is theoretically possible if the securities have increased in value by a large amount, but this is a rare event, as securities are inherently unlikely to increase in value much over their issue price. The most likely scenario might be where the securities were acquired as ‘distressed’ debt at a low percentage of the issue price, but the issuer recovered and was able to repay something nearer to the full loan.

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7.11 Conversions of securities TCGA 1992, s 133A – cash payments received on euroconversion of securities 7.11 ‘(1) This section applies where, under a euroconversion of a security that does not involve a disposal of the security and accordingly is not a conversion of securities within section 132(3)(a), a person receives, or becomes entitled to receive, any sum of money (‘the cash payment’). (2) If the cash payment is small, as compared with the value of the security concerned – (a) receipt of the cash payment shall not be treated for the purposes of this Act as a disposal of part of the security, and (b) the cash payment shall be deducted from any expenditure allowable under this Act as a deduction in computing a gain or loss on the disposal of the new holding by the person receiving or becoming entitled to receive the cash payment. (3) Where the allowable expenditure is less than the cash payment (or is nil) – (a) subsection (2) above shall not apply, and (b) if the recipient so elects (and there is any allowable expenditure) – (i)

the amount of the cash payment shall be reduced by the amount of the allowable expenditure, and

(ii) none of the expenditure shall be allowable as a deduction in computing a gain accruing on the occasion of the euroconversion, or on any subsequent occasion. (4) In this section – (a) “allowable expenditure” means expenditure which immediately before the euroconversion was attributable to the security under paragraphs (a) and (b) of section 38(1), (b) “euroconversion” has the meaning given by regulation 3 of the European Single Currency (Taxes) Regulations 1998.’ Analysis 7.12 This provision covers the case where a cash payment is received on the euroconversion of a security and is identical in its operation to TCGA 1992, s 133. It was inserted into the legislation in 1999 by the European Single Currency (Taxes) Regulations 1998 (SI 1998/3177). SI 1998/3177,

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Conversions of securities 7.13 reg 3 defines ‘euroconversion’ as the redenomination of a security into euros from the original currency in which it was denominated on issue. These provisions were presumably enacted in case the UK entered the eurozone, although the regulation appears to be effective for any redenomination into euros. Obviously, since the 2016 vote to leave the EU, this contingency seems somewhat remote. The likely need for this provision is because a sterling-denominated bond is not likely to convert to an integral number of euro-denominated bonds, because the currency conversion rates will not be integral. So, for example, a bond of £100 may be worth €113.45. If the bond were converted to euros, the bondholder might receive a €110 bond with a small cash payment representing the residual €3.45. TCGA 1992, s 134 – compensation stock 7.13 ‘(1) This section has effect where gilt-edged securities are exchanged for shares in pursuance of any enactment (including an enactment passed after this Act) which provides for the compulsory acquisition of any shares and the issue of gilt-edged securities instead. (2) The exchange shall not constitute a conversion of securities within section 132 and shall be treated as not involving any disposal of the shares by the person from whom they were compulsorily acquired but – (a) there shall be calculated the gain or loss that would have accrued to him then disposed of the shares for a consideration equal to the value of the shares as determined for the purpose of the exchange, and (b) on a subsequent disposal if the whole or part of the gilt-edged securities by the person to whom they were issued – (i)

there shall be deemed to accrue to him the whole or a corresponding part of the gain or loss mentioned in paragraph (a) above, and

(ii) section 115(1) shall not have effect in relation to any gain or loss that is deemed to accrue as aforesaid. (3) Where a person to whom gilt-edged securities of any kind were issued as mentioned in subsection (1) above disposes of securities of that kind, the securities of which he disposes – (a) shall, so far as possible, be identified with securities which were issued to him as mentioned in subsection (1) above rather than with other securities of that kind, and 197

7.14 Conversions of securities (b) subject to paragraph (a) above, shall be identified with securities issued at an earlier time rather than those issued at a later time. (4) Subsection (2)(b) above shall not apply to any disposal falling within the provisions of section 58(1), 62(4) or 171(1) but a person who has acquired the securities on a disposal falling within those provisions (and without there having been a previous disposal not falling within those provisions or a devolution on death) shall be treated for the purposes of subsections (2)(b) and (3) above as if the securities had been issued to him. (5) Where the gilt-edged securities to be exchanged for any shares are not issued until after the date on which the shares are compulsorily acquired but on that date a right to the securities is granted, this section shall have effect as if the exchange had taken place on that date, as if references to the issue of the securities and the person to whom they were issued were references to the grant of the right and the person to whom it was granted and references to the disposals of the securities included references to the disposals of the rights. (6) In this section “shares” includes securities within the meaning of section 132. (7) This section does not apply where the compulsory acquisition took place before 7 April 1976.’ Analysis 7.14 TCGA 1992, s 134 sets out the rules for conversions (since 7 April 1976) caused by the compulsory acquisition of shares for gilt-edged stock, which was most likely to occur on a nationalisation. This legislation is required because gilt-edged securities are normally outside the scope of capital gains tax by virtue of TCGA 1992, s 115. So an exchange of shares for gilt-edged securities, followed by a disposal of those securities, would mean that any gain on the shares at the time of the exchange will fall outside of taxation. The mechanism used is very similar to that of TCGA 1992, s 116 in respect of QCBs (see Part 3 of this book). In essence, the provision requires a gain or loss to be computed as if the shares had been sold at the exchange value deemed by the enabling legislation. The gain (or loss) will then come into effect when the gilt-edged securities are eventually disposed of by sale, redemption, etc. A disposal of only part of the holding of gilt-edged securities will bring into charge an appropriate part of the gain. The gain or loss will crystallise even though the disposal of a giltedged security is normally outside the scope of capital gains tax by virtue of TCGA 1992, s 115. This is because the gain or loss has not, in fact, arisen

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Conversions of securities 7.15 on the disposal of the gilt-edged security. It is, of course, the gain or loss on the disposal of the original shares, which is not outside the scope of capital gains tax. As gilts are fungible assets, gilts of the same kind can be held by a person who has acquired them by subscription or trade, as well as through a nationalisation, and it may be that gilts of the same kind were issued in more than one nationalisation. Therefore, there are specific identification rules: gilts disposed of are identified first with the compensation stock acquired as described in TCGA 1992, s 134(1) and then with compensation stock acquired earlier rather than later. Any further disposals will be identified with gilts acquired other than through the nationalisation and will not be within the rules of TCGA 1992, s 134. The exclusions listed in TCGA 1992, s 134(4) are husband and wife transfers (TCGA 1992, s 58(1)), transfers to a legatee on death (TCGA 1992, s 62(4)) and intra-group transfers between UK resident companies (TCGA 1992, s 171(1)). In each of these cases, however, the recipient under any of these provisions will suffer the held-over tax charge on the eventual disposal of the securities. The interesting point about these exclusions is that there does not appear to be any exclusion for conversion of a gilt-edged security. Perhaps gilt-edged securities are never converted, so no such provision was necessary. Where the securities are issued some time after the shares are effectively disposed of, TCGA 1992, s 134(5) tells us to treat the granting of the right to receive the gilt-edged securities as if that right were the securities themselves, so that a gain (or loss) is computed and can crystallise if the right to receive the gilts is sold before the gilts are actually issued. However, we assume that the issue of the gilts to the person originally entitled to them is not treated as the disposal of the right to receive the gilts in these cases! TCGA 1992, s 134(6) provides that this provision would also be in point in the event that securities of the body being nationalised were compulsorily acquired and replaced by gilt-edged securities. TCGA 1992, Sch 9, para 1 lists the securities that are deemed to be gilt-edged for the purposes of this legislation.

CONCLUSION 7.15 In this chapter, we have looked at the special rules for conversions of securities and the way in which the reorganisation provisions are applied to these transactions. On the way, we have had to consider, albeit briefly, what is meant by a security. 199

7.16 Conversions of securities

STAMP TAXES 7.16 Most conversions of securities will not give rise to any stamp duty charge. If the security is a debt instrument, it will not be within the scope of these taxes unless it has certain equity-like characteristics as set out in Chapter 2. If the security is a form of equity or otherwise within the scope of stamp duty, no charge will arise unless the conversion proceeds by way of repurchase of the old securities. Provided the old securities are merely redeemed or cancelled, there will be no acquisition. Finally, even if there is stamp duty on an acquisition of the old securities, it may be possible to claim group relief from stamp duty if, for example, both the issuer and the holder are members of a 75 per cent group.

VALUE ADDED TAX 7.17

A conversion of securities cannot give rise to output VAT.

Position of the securities-holder 7.18 Where the conversion takes place pursuant to the original terms of issue of the securities, in our view the securities-holder makes no supply: it is simply an implementation of the existing terms of the securities, not a disposal by the securities-holder for consideration. If the securities-holder is carrying on a relevant business in relation to the securities (and now the new shares or securities), his input VAT on any incidental expenses he runs up for the purpose of the exercise should be treated in the same way as input VAT incurred in relation to a bonus issue, see 6.34 above. This is so even if he receives a cash premium on the conversion (in addition to the new shares or securities). Where the conversion is ad hoc, the position may be different: the securitiesholder may be making an exempt supply of his securities. It does not follow, however, that any input VAT incurred will be wholly for the purpose of that supply: his position will be the same as the seller who does a share-for-share exchange, see 8.24 below.

Position of the company 7.19 The company makes no supply: Kretztechnik AG v Finanzamt Linz [2005] STC 1118, ECJ. If it is carrying on a business at all, any input VAT it has incurred in connection with the conversion exercise will normally be part of its residual input VAT.

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Part 3

Deemed reorganisations

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Chapter 8

Share-for-share exchanges

INTRODUCTION TO PART 3 8.1 This Part of the book is concerned with the legislation looking at certain transactions that are deemed to be reorganisations for tax purposes, even though they are not reorganisations as defined in TCGA 1992, s 126. The categories of transaction we will be looking at are: ●●

share exchanges (this chapter); and

●●

exchanges involving qualifying corporate bonds (Chapter 9).

Later on, in Chapter 14, we will be looking in detail at the facilities for pre-transaction clearances in respect of paper-for-paper transactions and the practical issues that arise.

PURPOSE OF THE LEGISLATION 8.2 Again, there is no assistance from the Notes on Clauses in explaining these exceptions to the general rules on disposals. Arguably, however, the same logic applies as it does to ordinary reorganisations, that the person either has not made a real disposal (conversions of securities) or that the disposal has not generated any cash to permit a tax liability to be paid. Alternatively, as always, we can ask: ‘why would Parliament wish to tax such a transaction?’. Looking at it commercially, a great many disposals may not take place if the purchaser always had to pay up the consideration in cash and in full at completion. So the ability to pay by giving loan notes, to be redeemed at a later date, or by issuing to the vendor some shares in the purchaser, allows a great deal of commercial flexibility in these matters, giving the purchaser the chance to defer payment of the consideration for new acquisitions either to a set timetable or, indeed, indefinitely. Meanwhile, the vendors do not lose out as they receive interest or dividends on the purchaser securities and are often able to sell those securities independently if they wish to realise their investment.

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8.3 Share-for-share exchanges Clearly, there is a great deal of sense in arranging that the tax system does not distort this sort of commercial decision making. Again, these provisions have existed in the capital gains legislation since the original short-term gains legislation was enacted in 1962, so their importance has always been considered fundamental to the proper operation of this tax. While they have been modified over the intervening 57 or so years, either to keep pace with commercial and legal changes or to prevent tax avoidance, the basic core of the legislative provisions has remained unchanged.

INTRODUCTION 8.3 The issue of shares or debentures in one company in exchange for the shares or debentures in another company is not a reorganisation within the meaning of TCGA 1992, s 126 (since the legislative test is that there is a reorganisation of a company’s capital). TCGA 1992, s 135, however, brings such an exchange within the provisions of TCGA 1992, ss 127–131 in certain circumstances so that, with the necessary adaptations, the exchange is treated as though it were a reorganisation of a company’s share capital. It is not necessary to make a claim that TCGA 1992, s 135 applies; the provisions of the section will apply if the conditions outlined in the section are satisfied. The only additional requirement is that the transactions are carried out for bona fide commercial reasons and do not form part of a scheme or arrangement of which the main purpose is the avoidance of tax, which is covered in Chapter 13. Again, the basic legislation was in place in 1962 and in the first capital gains tax legislation of 1965. As always, of course, the detail has changed several times in response to the usual stimuli of new commercial practice, changing tax rules and the need to close down loopholes. The legislation applies to the issue of shares or debentures by one company in exchange for shares or debentures in another company, so it is very flexible in its application. However, where a debenture that is involved in an exchange is a qualifying corporate bond (‘QCB’), there are special rules in TCGA 1992, s 116, which are discussed in detail in Chapter 9.

THE LEGISLATION TCGA 1992, s 135(1) – fundamental requirements 8.4 ‘(1) This section applies in the following circumstances where a company (“company B”) issues shares or debentures to a person in exchange for shares or debentures of another company (“company A”).’ 204

Share-for-share exchanges 8.5 Analysis 8.5 This subsection introduces the provision noting that the fundamental requirement for TCGA 1992, s 135 to apply is that there be a disposal by a person of shares or debentures to a company that issues shares or debentures as consideration (or as part of the consideration). TCGA 1992, s 135 can apply equally to an intra-group transaction (Figure 8.1) or to a disposal and acquisition (Figure 8.2). The use of the words ‘in the following circumstances’ makes clear that this is an exhaustive set of circumstances to which TCGA 1992, s 135 applies (which are set out in TCGA 1992, s 135(2) and are analysed in further detail below). Figure 8.1 Intra-group reorganisation

Figure 8.2 Disposal

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8.5 Share-for-share exchanges The provision clearly requires the issue of the new securities by the acquiring company, so a mere swapping of securities already issued is not sufficient (Figure 8.3). This might be seen as counterintuitive, given that TCGA 1992, s 135 is titled ‘Exchange of securities for those of another company’ and the transactions are commonly referred to as ‘share-for-share exchanges’ (including in the title to this chapter!). In practice, there are many reasons why a company might not want to issue shares as consideration. For example, where the vendor does not hold shares in the transferee prior to the transfer of the shares, the issue of shares as consideration might create a cross-shareholding which has implications for dividends or groupings. There could also be implications for ensuring that the right number of shares have been issued to appropriately reflect the fair market value of the shares that have been transferred, which might not be the case where the transferee is wholly owned by the vendor. In some jurisdictions, the issue of shares requires a corporate legal process to be completed, such as a notary or court approval which can be costly and time consuming, especially when the transfer is part of a wider transaction that needs to be implemented on the same day in a prescribed sequence. It is important to note that, where the conditions in TCGA 1992, s 135 are met, the treatment of such transactions as reorganisations is mandatory. Therefore, there is no option for a shareholder to choose to have the transaction treated as a disposal, for example, unless specifically permitted by legislation, such as the right to elect under TCGA 1992, s 169Q or 169R that TCGA 1992, s 135 should not apply. Otherwise, the only way to achieve that aim would be to structure the transaction differently. For example, a shareholder could arrange to sell the shares to the purchaser for cash, the moneys so received (after paying capital gains tax) then being used to subscribe for new shares or for debentures in the purchaser. In practice, this could be relevant where the conditions for both the SSE and TCGA 1992, s 135 apply. Under such circumstances, it might be preferable to have SSE apply rather than TCGA 1992, s 135 since an exemption is better than deferral of taxation. The interaction between these reliefs is discussed in further detail in Chapter 11.

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Share-for-share exchanges 8.5 Figure 8.3 Swapping shares

Also, there is no requirement that the company issuing the shares or the company whose shares are the subject of the transfer be UK resident, subject to the anti-avoidance provisions of TCGA 1992, s 137. Obviously, the vendor must be UK resident or otherwise subject to UK taxation of chargeable gains for there to be a charge to tax in the UK to which the provision can apply. This is a key differentiator between the deferral mechanisms in TCGA 1992, ss 135 and 171, with the latter requiring that both the transferor and the transferee are members of the same group and resident in the UK (or the asset is situated in the UK and is used for the purposes of a trade of a non-UK resident company in the UK through a permanent establishment). In practice, where the transferee is a non-UK resident entity, this alone will mean that TCGA 1992, s 171 is not available, whilst relief under TCGA 1992, s 135 might still be possible. Note that the exchange requirements of this provision mean that Company B must hold the shares in Company A directly (although the word ‘directly’ has not been used, this is implied by the requirements to hold a certain amount of the transferee’s ordinary share capital). The legislation would not apply if the exchange were to involve a subsidiary of Company B acquiring Company A, in consideration for which Company B issues shares to the shareholders of Company A (quite apart from this, such a transaction would not necessarily comply with UK company law) (Figure 8.4).

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8.5 Share-for-share exchanges Figure 8.4

The authors note that a possible interpretation of TCGA 1992, s 135(1) is that a company (Company B) issues shares in exchange for shares of another company (Company A) but issues these shares to a person other than the vendor, for example, to the parent of the vendor. The key to this interpretation is the use of the words ‘to a person’ in TCGA 1992, s 135(1) which, on a literal interpretation, could be read as meaning any person, rather than being narrowly construed to mean the vendor itself. This has been demonstrated in Figure 8.5. Here, B issues shares to H, being the parent of C, in exchange for C transferring the shares it held in A to B. One possible corporate law constraint is that the vendor and its parent will need to enter into a separate arrangement to compensate the vendor for giving up the shares in return for no consideration, to respect the directors’ fiduciary duties. Another issue could be that the transaction might constitute a distribution, although this might not be relevant where H is subject to corporation tax (as a result of the application of the distributions exemption in CTA 2009, Part 9A) but might become more relevant if H were an individual, subject to income tax. In the experience of the authors, this is a transaction that is lawful under US corporate law. However, when it has been proposed by US advisers in transactions involving UK vendors, it has been suggested by the UK legal advisers that this is not a lawful transaction under UK company law. So, whilst there may be technical arguments that support such a literal reading of TCGA 1992, s 135(1), the authors have never seen such a transaction carried out in practice. 208

Share-for-share exchanges 8.7 Figure 8.5

TCGA 1992, s 135(2) – the circumstances 8.6 ‘(2) The circumstances are –

Case 1 Where company B holds, or in consequence of the exchange will hold more than 25% of the ordinary share capital of A;

Case 2 Where company B issues the shares or debentures in exchange for shares as a result of a general offer –

––

made to members of company A or any class of them (with or without exceptions for persons connected with company B); and

––

made in the first instance on a condition such that if it were satisfied company B would have control of company A; and

Case 3 Where company B holds or in consequence of the exchange will hold the greater part of the voting power in Company A.’

Analysis 8.7 Although there is no available material to discern Parliament’s intention, we assume that these cases exist because the intention was to ensure that the exemption represented by TCGA 1992, s 135 was available for commercial takeovers and group reorganisations and not for mere portfolio 209

8.8 Share-for-share exchanges investments and the like. Indeed, the first versions of this legislation, in 1962 and 1965, only had two cases (FA 1962, Sch 9, para 12(2) and FA 1965, Sch 7, para 6(2)). One was where the company issuing the shares and debentures has, or in consequence of the exchange would have, control of the other company and the other was identical to Case 2, the public offer. Case 1 was replaced by the 25% test in 1977 and Case 3 was introduced in 1992. The amendment to Case 1 was never formally explained, but has always been accepted as a relieving provision, as the 100% rule sometimes operated harshly to deny relief, perhaps where a full takeover was not required (or possible) or where there was a joint takeover. Of course, the generosity of Parliament here was tempered by the fact that the same Act introduced the requirement for the transactions to be carried out for bona fide commercial reasons and not for the avoidance of tax (now TCGA 1992, s 137, see Chapter 13). Case 3 was introduced as part of the implementation of the EU Mergers Directive and was deemed always to have had effect. The first circumstance – Case 1 8.8 This case is largely self-explanatory in effect referring to the ownership of ordinary share capital in Company A both before and after the exchange. If Company B already holds at least 25% of the ordinary share capital in Company A, any transfer of shares or debentures in Company A to Company B in exchange for the issue of shares or debentures in B will necessarily satisfy the test in Case 1, as Company B will necessarily have more than 25% of the share capital of Company A after the transaction. If Company B does not have more than 25% of the ordinary share capital of Company A before the exchange, it will be necessary for B to acquire enough shares to exceed 25% of A’s ordinary share capital as part of the exchange transaction for these provisions to apply. In practice, the circumstances in which Case 1 applies are very often those where the vendor does not initially hold any shares in the transferee beforehand, but will hold more than 25% (and often 100% in a group scenario) of the ordinary share capital afterwards. This test is framed in terms of share capital of a company. However, TCGA 1992, s 135(5) allows the test to apply in respect of a member’s interests in a company where the company does not have share capital. TCGA 1992, s 135(4) sets out what is meant by ‘ordinary share capital’. This is discussed in further detail below.

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Share-for-share exchanges 8.10 The second circumstance – Case 2 8.9 The second case is more relevant to takeovers of public companies or companies with many shareholders. It applies where Company B makes a general offer to all shareholders or to all shareholders of a particular class of Company A on such terms that, if they were to accept the offer, Company B would have control of Company A. Usually, this would require the offer to be conditional upon Company B receiving sufficient acceptances to give Company B control of Company A. The initial terms of the offer are the critical factor here; the HMRC Manual (at CG52523) clarifies that the condition could be dropped whilst the offer was still open. If the condition were to be dropped and Company B did not receive sufficient acceptances to give it control, the second test would nevertheless have been satisfied in respect of any shares exchanged as a result of the offer. Where there are different classes of shares in Company A, it may be possible for B to acquire control of Company A by making an offer for one class of shares only. Provided that ownership of that class of shares would give B control of Company A, the requirements in Case 2 may be met. Control is defined in CTA 2010, ss 450 and 451 (via TCGA 1992, s 288(1)) as being the direct or indirect control over the company’s affairs by reference to possession of share capital, voting power, entitlement to assets on distribution or on a winding up. The important point about Case 2 is that it allows an offeror to make an open offer to the shareholders of a target, and to complete the transaction in respect of those shareholders that accept the offer, even if only a very few of them do. In such a case, the offeror may not acquire sufficient shares to satisfy the 25% test in Case 1 but it would be unreasonable to deny the relief to the vendor shareholders, just because other shareholders chose not to accept the offer. The third circumstance – Case 3 8.10 The third circumstance is made by reference to ownership of voting power held by Company B in Company A. The circumstance was introduced to comply with EC law following the introduction of the EU Mergers Directive1. The three circumstances are not mutually exclusive. In many cases, particularly in an intra-group transfer or where there is a full takeover of a target company, so that the shares acquired by Company B represent the entire issued share capital of Company A, all three cases might be satisfied.

1 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended).

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8.11 Share-for-share exchanges TCGA 1992, s 135(3) – application of reorganisation provisions 8.11 ‘(3) Where this section applies sections 127 to 131 (share reorganisations etc) apply with the necessary adaptations as if company A and company B were the same company and the exchanges were a reorganisation of its share capital.’ Analysis 8.12 TCGA 1992, s 127 provides that where there has been a reorganisation it shall be treated as though there has been no disposal of the original shares and no acquisition of new shares. Instead, the original shares and the new holding are treated as though they were the same asset acquired at the same time that the original shares were acquired. In essence, the legislation applies the two fictions of the reorganisation provisions: the no-disposal fiction and the single composite asset fiction. Taken at its simplest, if we apply this rule to a share-for-share exchange, the shares issued by Company B are to be taken as being the same as the shares that Company B acquires in Company A on the exchange. So the original shareholders of Company A are treated as having acquired their shares in Company B at the same time and for the same cost as their shareholdings in Company A. The effect of the legislation is to roll over any gain arising on the disposal of the Company A shares until there is a disposal of the Company B shares. All the other consequences of TCGA 1992, ss 127–131, such as consideration received or given as part of the exchange transaction, will also apply as appropriately adapted. The legislation is silent as to what ‘necessary adaptations’ are required to enable a share-for-share exchange to be treated as a reorganisation. This has not caused any difficulty in the context of the simple case described above. However, it has caused problems and spawned two well-known tax cases in the context of the wider ramifications, such as the base cost of the company that was transferred.

The Woolcombers case 8.13 In Westcott v Woolcombers Ltd, 60 TC 575, three subsidiaries were bought for £1.27 million and transferred within the Woolcombers group in exchange for an issue of shares by the transferee company, Topmakers. Six years later, the subsidiaries were liquidated and the proceeds of £600,000 212

Share-for-share exchanges 8.13 represented a capital loss. The company contended that the base cost of the subsidiaries was unaffected by the operation of TCGA 1992, s 135 (then FA 1965, Sch 7, para 6(1)) which only applied to fix the base cost of the shares of Topmakers. The shares of the subsidiaries had been transferred between UK resident members of a group and TCGA 1992, s 171(1) (then FA 1965, Sch 13, para 2(1)) operated so that the base cost of the subsidiaries to Topmakers was the original cost of £1.27 million. Therefore, the loss on the liquidation was an allowable loss for capital gains tax purposes. The Crown contended that the effect of the no-disposal fiction on the sharefor-share exchange was that there was no disposal on the transfer of the shares in the subsidiary within the UK group, with the result that (now) TCGA 1992, s 1711 did not apply. Instead, the shares of the subsidiaries should be deemed to have been acquired at their market value as if on a connected party transaction (ie applying TCGA 1992, s 17 by virtue of TCGA 1992, s 18), with the result that no allowable loss would have arisen as market value at the date of the exchange was substantially lower than the original cost. The difficulties in the case arise as a result of trying to determine the scope of the ‘necessary adaptations’ to TCGA 1992, ss 127 et seq. That is, while the straightforward analysis is that the shares issued by the transferee are deemed to be the same as the shares transferred, the analysis in respect of the target shares that were transferred is more complex. The question was whether the no-disposal fiction also applied to the transferee company that acquires the shares of the target, with the result that it does not acquire the shares as a result of a disposal. In finding for the taxpayer company in the Court of Appeal, Fox LJ gave a very lucid judgment that imposed a clear logic on the situation and his comments are worth quoting at length. He said that TCGA 1992, s 135 is: ‘Concerned to ensure that where a shareholder in company A exchanges that shareholding for an issue of shares in company B, the shareholder is not taxed on that transaction … On the other hand, company B has, in law, become the owner of the shares in company A. That is a situation which has no counterpart in a one company situation. The composite single asset fiction cannot therefore operate in relation to Topmakers. If one of the fictions cannot be applied to Topmakers, I do not think that the other can be applied either. In the two companies situation, the purpose can be achieved by limiting the fictions to the tax consequences of the transaction to the owner of the original shares (Holdings). That, it seems to me, sufficiently effectuates the purpose of the enactment. The single composite asset fiction simply cannot be applied to Topmakers, and to apply the no-disposal fiction to Topmakers produces the situation that Topmakers, which has undoubtedly acquired the shares in the 213

8.13 Share-for-share exchanges three companies by an ordinary transfer inter vivos, must be assumed to have done so without any disposal to it at all. I see no reason to accept so unreal a result when the purpose of the legislation, as I read it, can be achieved by limiting the operation of the fictions to the tax position of Holdings. That result, I appreciate, does not avoid artificiality itself, but we are dealing with fictions and, in pursuance of the statutory direction, adapting them, as realistically as one can, to a situation which is very different from that for which [section 127] itself was designed. The no-disposal fiction cannot be sensibly applied to a two companies situation without severe limitations any more than the single composite asset fiction can. To limit the no-disposal fiction to the tax consequences of the exchange to Holdings seem to me less objectionable than assuming that an actual transfer of the shares in the three companies, which undeniably did take place, was something that never took place at all. I bear in mind that [section 135] specifically requires us to make adaptations.’ Put simply, he agreed that there was no completely logical answer to the question of what the necessary adaptations should be to apply the composite asset and the no-disposal fictions to the situation where a company was being transferred within a group on the exchange of shares. On balance, it was less objectionable to limit the fiction so that it did not apply to the acquisition of the target shares transferred to Topmakers, so the shares could be deemed to be acquired as a result of a disposal and the ‘no gain no loss’ rule could apply. The problem, of course, is that applying the words of the legislation, no disposal can be deemed to have taken place. To achieve the result that the ‘no gain no loss’ rule can apply, a selective use of the fiction must be made or, as Fox LJ himself put it: ‘The notion of an acquisition of an asset by Topmakers without a disposal may be regarded as inelegant, but it is the necessary result, so the Crown says, of replacing one asset by two. Somebody acquires an asset without a disposal. I follow that, but the argument seems to me to underrate the deep difficulties which result from the application of [section 135] to a two companies situation. Something has to give way. Substantial adaptation is necessary.’ One effect of this decision is that it opened up the possibility of taxing the same economic gain twice or allowing the same economic loss twice due to ‘layering’. When a company carries out an internal reorganisation, as in the Woolcombers case, the result of that case is that the base cost of the original subsidiary is effectively duplicated, so that the same base cost applies both

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Share-for-share exchanges 8.14 to the shares in the subsidiary itself and to the shares issued by the transferee company. Therefore, a disposal of either the original company or the transferee company would generate the same gain or loss for capital gains tax purposes. If the subsidiary were sold first and the transferee company were sold later, the same economic gain or loss could arise twice. This ‘layering’ of gains or losses is either an aspect of the scheme of the legislation which must simply be accepted or an illogicality that must be rejected if at all possible depending upon one’s point of view. The Revenue argued this point in the Woolcombers case, but Fox LJ said: ‘I am not satisfied that the legislation itself discloses such a policy. I think that Mr Park, for the taxpayer, rightly asserts that an increase in the value of an asset can give rise to a liability to tax on the part of the company which owns the asset and to further liability on a disposal by a person owning, directly or indirectly, a share in that company.’ In other words, the judge was inviting Parliament to consider whether the law required changing if the result of the legislation as it then stood was not considered acceptable. This is what happened with the enactment in FA 1988 of what is now TCGA 1992, s 171(3) which disapplies the normal ‘no gain no loss’ provisions where the intra-group transfer has occurred as a result of a deemed reorganisation within TCGA 1992, s 135. As a result, in share-for-share exchanges, the transferee’s base cost in the target company on an internal reorganisation such as in Woolcombers is market value at the date of acquisition following TCGA 1992, ss 17 and 18. The interaction between the reliefs provided by TCGA 1992, ss 135 and 171 and the SSE are considered in further detail in Chapter 11.

1 For the purposes of simplicity, the TCGA 1992 statutory references will be used throughout the discussions of these cases.

The NAP Holdings case 8.14 When these same issues were argued again in the case of NAP Holdings UK Ltd v Whittles 67 TC 166, the positions had been reversed. The taxpayer was now arguing that the intra-group transfer should have been treated as being at market value. The group had acquired a subsidiary for £7.5 million and later carried out a share-for-share exchange whereby that subsidiary became

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8.14 Share-for-share exchanges a subsidiary of NAP Holdings UK Ltd (‘NAP’) at a time when the subsidiary had a market value of £430 million. Unsurprisingly, when the subsidiary was later sold for an even greater sum, NAP was keen to argue that the base cost for the disposal should be £430 million, not £7.5 million! The final decision of the House of Lords in NAP Holdings was to uphold the reasoning of the Woolcombers case. Normally, the only way the reasoning of the Woolcombers case could be overturned in a later case would be by the House of Lords. However, in the NAP Holdings case, the Court of Appeal believed itself able to do so on the basis that the relevant legislation had been consolidated into new Acts (ICTA 1970 and CGTA 1979) and that new Acts should be treated in effect as new legislation to be considered with fresh eyes. As Nolan LJ put it, ‘certainly I cannot, for my part, accept the Woolcombers decision as having survived the enactment of the 1970 and the 1979 Acts’. This became irrelevant once the case reached the House of Lords as the House of Lords was not bound by the Court of Appeal decision in Woolcombers, although, as noted above, they agreed with it. The courts were also asked whether it was relevant to consider the intention that could be inferred from anti-avoidance legislation in determining the original intention of the earlier legislation where the potential for avoidance arose. That is, was it permissible to conclude that the anti-avoidance legislation was enacted on an erroneous belief and was therefore otiose? On this point, the House of Lords concluded that anti-avoidance legislation had indeed been drafted on an erroneous interpretation of the former legislation. In the words of Lord Keith: ‘For the reasons given by Hoffmann J and Fox LJ in the Woolcombers case, which I find convincing, I am of the opinion that section [135] is likewise intended to affect only the tax position of the shareholder who disposes of his shares in one company in exchange for shares in another company, and not the tax position of that other company. I regard as particularly important the emphasis placed on the Woolcombers case on the policy aspects of the matter. In relation to a group of companies, that policy is that gains and losses should be computed by reference to the consideration paid when an asset comes into the group and the consideration received when it goes out. As Fox LJ observed, it is hard to see why there should be a difference in tax consequences between the transfer of shares within the group in consideration of an issue of shares, and transfers for some other consideration. That the legislation as it stands in the consolidation Acts is capable of leading to the anomalies is undoubted, but I agree with Millett J that the most serious of these arise because the draftsman of the later provisions was under an erroneous impression as to the proper construction of the earlier.’

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Share-for-share exchanges 8.16 As we have seen, for practical purposes, the position in these cases was reversed for the future by the provision which is now TCGA 1992, s 171(3), which disapplies TCGA 1992, s 171(1) where TCGA 1992, s 135 applies. The more lasting jurisprudential significance of the judgments derives from the attempts made by the judges to adapt and apply the fictions created by the reorganisation code to practical examples. The arguments described above are characterised by a reluctance to guess at a parliamentary intention based on economic results. If an interpretation resulted in a ‘layering’ of capital gains or losses, then this was preferred to a result which involved stretching the statutory fictions any further than was necessary to achieve the most obvious intention of the legislation. These cases therefore provide helpful guidance as to the limits that should be applied in any ‘purposive’ construction of the reorganisation tax legislation. Questions of economic results should not be used as an excuse to stretch the meaning of difficult legislation, as it is by no means the case that sufficiently clear basic principles of capital gains tax legislation exist that would legitimate such speculative interpretation. TCGA 1992, s 135(4) and (5) – meaning of ‘share’ 8.15 ‘(4) In this section “ordinary share capital” has the meaning given by section 1119 of CTA 2010 and also includes – (a) in relation to a unit trust scheme, any rights that are treated by section 99(1)(b) of the Act (application of the Act to unit trust schemes) as shares in a company, and (b) in relation to a company that has no share capital, any interests in the company possessed by members of the company. (5) This section applies in relation to a company that has no share capital as if references to shares in or debentures of the company included any interests in the company possessed by members of the company.’ Analysis 8.16 The starting point for the definition of ‘ordinary share capital’ is that given in CTA 2010, s 1119: ‘all the company’s issued share capital (however described), other than capital the holders of which have a right to a dividend at a fixed rate but have no other right to share in the company’s profits’. The definition of ‘ordinary share capital’ for the purposes of TCGA 1992, s 135 also extends to units in a unit trust which are treated as shares by TCGA 1992, s 99(1)(b) and to any interests in the company held by members where that 217

8.17 Share-for-share exchanges company has no share capital. This last change was very welcome as previously a number of different types of company were unable to take advantage of the reorganisation or reconstruction provisions. TCGA 1992, s 135(6) – anti-avoidance 8.17 ‘(6) This section has effect subject to section 137(1) (exchange must be for bona fide commercial reasons and not part of a tax avoidance scheme).’ Analysis 8.18 This provision is self-explanatory and will be discussed in detail in Chapter 13.

EXAMPLES 8.19 Example 8.1 Richard Hale plc decides to invest in Stanborough Ltd, a private company. Stanborough is owned by various members of the Parkway family. Richard Hale plc offers to buy the 20% of Stanborough owned by Jeremy Parkway. The consideration offered is 1 plc share for every 5 Stanborough shares held by Jeremy. Is this potentially a reorganisation? Analysis: This is not within Case 1 as Richard Hale would not hold (and does not already hold) 25% or more of the share capital of Stanborough. Nor is it within Case 2 as there is no general offer to the shareholders of Stanborough and Case 3 is not in point as Richard Hale would not acquire (and does not already have) voting control of Stanborough. Therefore, this cannot be a reorganisation for the purposes of TCGA 1992, s 135. Example 8.2 Richard Hale plc has now acquired 20% of Stanborough Ltd. The other 80% of Stanborough is still owned by members of the Parkway family. Richard Hale plc offers to buy the rest of the shares. The consideration offered 218

Share-for-share exchanges 8.19 is again 1 plc share for every 5 Stanborough shares. Is this potentially a reorganisation? Analysis: This potentially falls within Case 1. Richard Hale already has 20% of the share capital of Stanborough and, if the holders of more than 5% accept the offer, this is sufficient to bring the proposed transaction within the scope of TCGA 1992, s 135. Case 2 is also in point, as this is a general offer to the members of Stanborough whereby, if the offer were accepted, Richard Hale would have control of Stanborough. Case 3 is similar to Case 1. If we assume that all the shares carry the same voting rights, Richard Hale already has 20% of the voting power of Stanborough and, if the holders of more than 30% of the other shares accept the offer, this exchange would be within Case 3. In this case, Case 1 (requiring more than 25% of the ordinary share capital) will be satisfied before Case 3 (requiring more than half the votes). But it is easy to imagine a scenario where a large proportion of a company’s voting power is in one class of share, so that an exchange involving only that class might satisfy Case 3 but not Case 1. This demonstrates that the transaction could be a reorganisation, depending on how many Stanborough shareholders accept the offer, so that Cases 1 and/or 3 might apply. But the better approach might be to rely on Case 2, so there is no doubt that TCGA 1992, s 135 applies. Example 8.3 A few months later, Hailebury plc makes an offer to all the shareholders of Richard Hale. The offer is a paper-for-paper exchange offering 1 Hailebury share for every 2 Richard Hale shares. The offer is dependent on sufficient acceptances that Hailebury would own at least 90% of the share capital of Richard Hale. Otherwise, the offer would lapse. Analysis: This potentially falls within Case 1, as in Example 8.2, if sufficient Richard Hale shareholders accept the offer. Case 2 is, however, likely to be more relevant here as this is a general offer to all Richard Hale shareholders with a condition that, if satisfied, would mean that Hailebury had control of Richard Hale. While Case 3 might also be in point, it is sufficient that the proposal falls within Case 2 at least. 219

8.19 Share-for-share exchanges Example 8.4

The base cost of A and B is £100 each. A’s current market value is £10,000, B’s is £5,000. Assuming that this is a reorganisation under TCGA 1992, s 135 (and ignoring the substantial shareholding exemption), what is the base cost to H of the total shareholding in B after the transaction and what is B’s base cost in A? What would the answers have been if the transaction did not amount to a reorganisation (imagine, for example, that it was not carried out for bona fide commercial reasons) and on the assumption that these are all UK tax resident entities? Analysis: By virtue of TCGA 1992, s 135(3), the base cost that H obtains in the new shares issued by B is the same as the base cost that H had in A, ie £100. The no-disposal fiction of TCGA 1992, s 127, applied by TCGA 1992, s 135(3), means that the shares issued by B to H are treated by H as being the same as the shares of A that H no longer has, with the same base cost and acquired at the same time as those shares in A. Therefore, H now has a total base cost in B of £200. B’s base cost in A will be the open market value of A at the time of the transaction, being £10,000. Although TCGA 1992, ss 135(3) and 127 treat H as not having disposed of A, B is treated as having acquired A (following the Woolcombers and NAP Holdings cases). This is an intra-group transfer but TCGA 1992, s 171(1) is disapplied by s 171(3) and the normal rule in TCGA 1992, ss 17 and 18 will apply to deem B’s acquisition of A as having been at market value. If this were not a reorganisation transaction, the result would be that H has made a disposal for capital gains tax purposes. However, this is an

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Share-for-share exchanges 8.19 intra-group transaction and TCGA 1992, s 171(1) would apply, so that A is deemed to be sold by H and acquired by B at a value that gives no gain and no loss, ie cost plus indexation. Ignoring indexation, this tells us that B’s base cost in A will be £100. (NB Note also that TCGA 1992, Sch 7AC, para 6 tells us that any ‘no gain no loss’ transfer cannot be exempt under the substantial shareholding exemption so the substantial shareholding exemption cannot apply to this intra-group transaction.) In a non-reorganisation, the shares issued by B to H will be subject to the normal rules of TCGA 1992, ss 17 and 18, ie H’s acquisition of those shares will be treated as having been at market value, so that the base cost of the newly-issued shares would normally be £10,000 and H’s base cost in B would now sum to £10,100. Note, however, that if B’s liabilities exceeded its assets, it might be that the shares issued by B to H on the acquisition of A do not have an open market value of £10,000 and may, indeed, be worthless. This was, in fact, the issue in the Young, Austen & Young case (see Chapter 5 at 5.4) where the shares issued were agreed to be of no economic value.

Example 8.5

The base cost of C is £100 and its market value is £10,000. Assuming that this is a reorganisation under TCGA 1992, s 135 (and ignoring the substantial shareholding exemption), what is the base cost to H of the total shareholding in B after the transaction and what is B’s base cost in A? What would the answers have been if the transaction did not amount to a reorganisation (for example, if it was not carried out for bona fide commercial reasons)?

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8.19 Share-for-share exchanges Analysis: In the reorganisation scenario, the answers are largely the same as for Example 8.4. The base cost that H obtains in the new shares issued by D is the same as the base cost that H had in C, ie £100. The no-disposal fiction of TCGA 1992, s 127, applied by TCGA 1992, s 135(3), means that the shares issued by D to H are treated by H as being the same as the shares of C that H no longer has, with the same base cost and acquired at the same time as those shares in C. Therefore, H has a base cost in its shares in D of £100. D’s base cost in C will be the open market value of C at the time of the transaction, being £10,000. Again, although TCGA 1992, s 135(3) and TCGA 1992, s 127 treat H as not having disposed of C, D is treated as having acquired C following the Woolcombers and NAP Holdings cases. This is not an intra-group transfer, so TCGA 1992, s 171(1) does not apply. Nor are H and D connected parties, so TCGA 1992, ss 17 and 18 also do not apply, but the acquisition cost of C to D is the market value of C on the basis of this being an arm’s-length transaction. If this were not a reorganisation transaction, the result would again be that H has made a disposal for capital gains tax purposes. Since this is not an intra-group transaction, TCGA 1992, s 171(1) does not apply, so the disposal is for the consideration received, which in practice will be equal to the value of the shares received. Therefore, H will have a chargeable gain in respect of the gain on disposal of C, unless the substantial shareholding exemption applies. And D’s base cost in C will be £10,000. In a non-reorganisation, the shares issued by D to H will also be treated as having a base cost equal to the proceeds given for the shares (ie £10,000, as the shares in C are the consideration for these newly issued shares). TCGA 1992, ss 17 and 18 do not apply as the transaction is between unconnected parties and is on arm’s-length terms. Therefore, even if the shares issued by D were, in fact, worthless, there is no mechanism to adjust the base cost for capital gains tax purposes. Putting it another way, TCGA 1992, s 17 only applies where a transaction is not a bargain made at arm’s length, or is between connected parties; it does not apply where a person has made a bad bargain or failed to carry out adequate due diligence. Overall, where the disposal to a third party is not a reorganisation, as in Example 8.5, both the shares of C held by D and the consideration shares issued by D have the proceeds given as their base costs for capital gains tax purposes (which, in practice, will likely be the value of the shares in C).

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Share-for-share exchanges 8.19 Example 8.6

Analysis: First, an unincorporated association, despite not being a body corporate, is still a ‘company’ for the purposes of capital gains tax (TCGA 1992, s 288)1. A company limited by guarantee does not have share capital, but TCGA 1992, s 135(4)(a) and (5) tells us to treat companies that do not have share capital as if they do have share capital, essentially treating the members’ interests in the company as being analogous to share capital for these purposes. Thus, the members of the unincorporated association are giving up their membership rights in the association in return for membership rights in the guarantee company and this transaction is capable of being a reorganisation for tax purposes under TCGA 1992, s 135. More importantly, this is not a theoretical position: we have actually advised on such a transaction and it was treated as a reorganisation for tax purposes. This is a particularly useful mechanism for incorporating unincorporated clubs and associations. A question we have frequently been asked is whether the incorporation relief (TCGA 1992, s 162) can be used to incorporate such businesses. The simple answer is that this is not possible, because TCGA 1992, s 162 only applies to transferors that are not companies, and unincorporated associations are companies, as noted above. However, if the owners of the unincorporated association were to set up a new company, either limited by guarantee or by share capital, they could use the share exchange provisions of

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8.20 Share-for-share exchanges TCGA 1992, s 135, as outlined here, to swap membership of the association for membership rights or shares in the company, as in the example. Indeed, it may be that, as a matter of law, following the exchange the company simply owns all the assets of the association, which ceases to exist. Although we have not obtained a legal analysis of the point, it seems reasonable to suggest that, since an association only exists when a number of people are associated for a given purpose, once the association only has a single member, then it no longer exists as an association. Whatever the wider legal analysis, we have successfully used this on a number of occasions to help various unincorporated associations, such as sports clubs or trade associations, to incorporate into a limited company.

1 A company is defined as ‘any body corporate or unincorporated association’.

INTERACTION WITH CAPITAL GAINS DEGROUPING CHARGE 8.20 The changes in FA 2011 to the capital gains degrouping charge, referred to in Chapter 1, introduced a new complication in respect of the share-for-share exchange rules. Consider the following position (Figure 8.6). Figure 8.6 Reorganisations and degrouping

When Company B leaves Company A’s group, it is holding Company C, which was transferred to it by Company A less than six years earlier. So there is a 224

Share-for-share exchanges 8.21 degrouping event, as defined by TCGA 1992, s 179, as a result of a group disposal (the disposal by Company A of Company B). Under the rules explained in Chapter 1 (see 1.10), any gain on the deemed disposal and reacquisition of Company C by Company B is added to the consideration received by Company A for selling Company B (TCGA 1992, s 179(3D)). Similarly, if the degrouping calculation yields a loss, that is deducted from the consideration. However, under TCGA 1992, s 135, Company A is deemed not to have disposed of Company B, so there is no group disposal to which the deemed further consideration can be applied. Instead, TCGA 1992, s 179(3E) tells us to hold over the deemed gain until Company A disposes of the shares in Company P, the new holding, when it is brought into charge as a gain on the disposal of the new holding. So the gain on the deemed disposal of Company C by Company B is charged on Company A when Company A disposes of the new holding, the shares in Company P. Alternatively, if there was a degrouping loss it would be deducted from any gain on the subsequent disposal. The other point to remember, of course, is that a degrouping event involving shares of a company might, itself, be subject to the substantial shareholding exemption, in which case TCGA 1992, s 179(3E) results in the overall gain falling within the exemption.

CONCLUSION 8.21 In this chapter, we have seen how the legislation designed to relieve reorganisations of share capital from taxation has been adapted (or, arguably, not adapted) to offer the same level of relief for paper-for-paper transactions which do in reality constitute real disposals, albeit they do not necessarily generate any cash. We have also seen how Parliament’s decision to refer to such vague concepts as ‘necessary adaptations’ can lead to confusion and the need for the courts to opine on the matter. In this case, we suggest that the courts came to an eminently sensible position on the legislation in front of them. If Parliament imposes a statutory fiction on taxpayers, that fiction has to be limited to the immediate requirements of policy (so far as that can be discerned) and cannot be allowed to leak out into other parts of the legislation. This dictum has also been applied by the courts in analysing provisions elsewhere in the Taxes Act. If the enactment of TCGA 1992, s 171(3) is an indication of the original intention of Parliament, then it is clear that the legislation only works now because of the requirement that exchanges be for bona fide commercial reasons and not part of tax avoidance schemes, inserted into the tax code at the same 225

8.22 Share-for-share exchanges time as TCGA 1992, s 171(3). This is clear from the cases of Floor v Davies 52 TC 609, Furniss v Dawson 55 TC 324 and Craven v White 62 TC 1, discussed in Chapter 13.

STAMP TAXES 8.22 In general, if shares in X are transferred to Y in return for the issue of shares in Y, a stamp duty charge will arise, payable by Y and based on the value of the Y shares issued (FA 1999, Sch 13). Reliefs may be available to reduce the charge to nil as explained in Chapter 2, where: ●●

Y and the original shareholder of X are members of a 75 per cent worldwide corporate group (group relief, FA 1930, s 42);

●●

the transaction is the insertion of a new holding company above X (FA 1986, s 77); or

●●

the transaction takes place in the course of the acquisition by Y of an undertaking of X’s shareholder, of which the shares in X form a part (FA 1986, s 75).

If the transaction does not qualify for one of these reliefs, stamp duty will be due. Particular care needs to be taken with regard to FA 1986, s 77A from 29 June 2016 as this introduced new anti-avoidance provisions into FA 1986, s 77 that affect many previously ‘normal’ share-for-share transactions. Proposals have been made to amend legislation so that transfers of unlisted securities to connected companies will be caught by the extended market value rule where there is an issue of shares by way of consideration for the transfer. The legislation will amend the rules on share-for-share exchanges so that most share-for-share exchanges which are part of a partition demerger arrangement will not have a disqualifying arrangement for the purposes of those sections. Sometimes, for example when a dissident minority shareholder threatens to prevent the transaction, it may proceed by way of a court-approved cancellation of the old shares of X, with new shares being issued to Y. No stamp duty should arise on such cancellation and reissue.

VALUE ADDED TAX 8.23 None of the transactions described in this chapter generate output VAT. Either they will be outside the scope of VAT, as where the seller is not carrying on any relevant business for VAT purposes, or, as regards the buyer, 226

Share-for-share exchanges 8.24 where the buyer is issuing shares; or if the seller is carrying on a relevant business any supply by him will be exempt for, or sometimes outside the scope of, VAT (see below). The main issue that arises is whether the party in question is entitled to a refund of his input VAT on professional fees and other costs in relation to the transaction.

The position of the sellers 8.24 The first question is always whether the seller is making his disposal in the course of a business carried on by him. This is dealt with at 3.6 above. If he is not, his disposal is outside the scope of VAT and he can recover no input VAT that he incurs for the purposes of it. Where, however, the seller is a member of a VAT group, see 3.11. If he is carrying on a relevant business, his disposal will normally be an exempt supply: Value Added Tax Act 1994 (‘VATA 1994’), Sch 9, Group 5, Item 6. If his disposal is to a business buyer elsewhere in the EU (but outside the UK) his disposal will technically be outside the scope of VAT (without right of recovery) – VATA 1994, s 7A, Sch 4A, paras 1–9A – but the consequences are very little different. But if the buyer belongs outside the EU the seller hits the jackpot: his disposal will be outside the scope of VAT but, with the right of recovery, effectively zero-rated: VATA 1994, s 7A, Sch 4A, para 16; VAT (Input Tax) (Specified Supplies) Order 1999, SI 1999/3121. If his supply is exempt, or outside the scope without the right of recovery, one might think that any input VAT run up by him wholly for the purpose of the sale would be irrecoverable: VATA 1994, s 26 and VAT Regulations 1995, SI 1995/2518, reg 101 and indeed this is what the case of BLP Group Plc v Customs & Excise Commissioners [1995] STC 424, ECJ held. The taxpayer company ran a (taxable) business of providing management and marketing services to its subsidiaries. It sold one subsidiary principally in order to generate cash to reduce the debts of its continuing business. It argued that the expenses that it had run up were thus used not only for the purpose of the immediate sale but also to benefit its continuing business, and were therefore a general overhead. This argument was rejected by the ECJ. But more recently, in a case where the facts were remarkably similar, Skatteverket v AB SKF [2010] STC 419, ECJ, the BLP principle was distinguished. It was held that: ●●

where the seller will have a business after the transfer, and

●●

the purpose of the transfer was, at least in part, to benefit that continuing business (or the group’s business, if the transferor is a member of a VAT group), and

●●

the expenses are not, on the facts, cost components of the consideration received for the shares, 227

8.24 Share-for-share exchanges expenses incurred for the purpose of the sale will count as general overheads so that, if the continuing business is wholly taxable, they will be fully recoverable. The transferor will not often have difficulty with the third bullet point. The consideration he receives will almost always depend on market factors, rather than the costs he happens to have incurred. However, it is important to appreciate that he will only pass the first two bullet points if he is carrying on a continuing business and his purpose is that it will benefit in some way from the sale. This will often not be so in the case of the transactions discussed in this chapter where the transferor receives only, or very largely, shares or securities as consideration, and little or no cash. But he can argue it where, for example: ●●

he receives, on the sale, a significant amount of cash, which he is to use for the purpose of his continuing business; or

●●

he intends to sell or redeem the acquired shares or securities at an early date and use the proceeds for the purpose of his continuing business; or

●●

he will be rendering taxable management services or the like to the company shares or securities in which he is acquiring; or

●●

the shares he is acquiring are a trade investment, see 3.6 above.

In the authors’ view, if the seller passes the three bullet point test and his continuing business is fully taxable he is entitled to fully recover the input VAT on his incidental expenses of the transfer. It is implicit in the SKF judgment that the exempt sale of shares should not be taken into account at all: see in particular para 72 (‘solely attributable to downstream economic activity’) and the fiscal neutrality argument in paras 66–70 and 73. As regards the UK partial exemption rules, it should be argued that the ECJ’s interpretation of the VAT directive overrides those rules. Alternatively, if the seller is on the standard method, VAT Regulations 1995, reg 101(8) is not in point, because on the facts the inward supplies in question are not ‘used’ for the financial supply (the transfer of shares); in some cases it can be argued that the transfer of shares is ‘incidental to’ the seller’s business and should be ignored for that reason (VAT Regulations 1995, reg 101(3)(b)); in other cases the seller can elect for his attribution to be based on ‘use’ (VAT Regulations 1995, reg 101(2)(e)) and so again the transfer of shares should be ignored. If the seller’s continuing business is partially exempt the same principles apply, but as a result of its being partially exempt he will end up with a disallowance of a proportion of the input VAT. If the seller has a special partial exemption method, he will, of course, need to look at its terms, but again it should be argued that the ECJ’s interpretation of the VAT Directive overrides. Some of the other arguments made above about VAT Regulations 1995, reg 101 are also likely to be relevant. Note that VAT Regulations 1995, reg 103B will not be relevant, even if the transfer of 228

Share-for-share exchanges 8.25 shares is ‘incidental’, because we are postulating that the inward supplies are not technically used at all for the transfer of shares. If the transferor does not pass the three bullet point test he should assume that his input VAT will be attributable to his exempt supply of shares and therefore be irrecoverable (unless it is to a transferee outside the EU, when it should all be recoverable, see above).

Use a nominee belonging outside the EU? 8.25 We have seen how a disposal of shares to a buyer who belongs outside the EU is effectively a zero-rated supply. At first sight it might seem to be possible for a transferor to take advantage of this – if the SKF principle does not help him – by arranging to dispose of the shares to a nominee (N), belonging outside the EU, for the real buyer (B), belonging inside. In the VAT Tribunal case of Water Hall Group plc [2002] STI 1801, where shares were issued to a nominee for a beneficial owner, it was held on the facts that the issuing company’s supply was to the nominee, not the beneficial owner (this was in the days when an issue of shares was thought to be a supply). However, using this device in the case of a share-for-share exchange is fraught with difficulty. ●●

Commercially the new shares or securities need, of course, to be issued by B, not N. This will mean that B will have to be a party to the sale contract, or at least a collateral contract (or N must be a party as agent for B as well as in its own right).

●●

To obtain the CGT roll-over, B must issue the shares or securities in exchange for the shares being sold: again this to our mind means that B, as well as N, must be a party to the contract or a collateral contract. Furthermore, B would need to be sure that the acquisition fell within Case 2 in TCGA 1992, s 135(2), see 8.6 above, in other words that there is a general offer to all the shareholders of Target: under Case 1 or Case 3 B has to hold the shares in Target, and N’s holding them will not do.

If B is a party to a contract with the sellers (either direct or by N acting as agent for it) that gives HMRC a lever to argue that B is the real recipient of the supply. It is better to leave the scheme for straight sales of shares for cash. Even here, while it will no doubt be clear in the documents that N is a nominee for B (if only to ensure that N can recover for breach of warranty etc by reference to B’s losses), it should be expressly stipulated that N is not an agent for B. B should not be a party to the purchase contract, though it can enter into a separate guarantee of N’s obligations if desired. In any event, there is always 229

8.26 Share-for-share exchanges a risk that HMRC will seek to invoke the anti-avoidance ‘abuse’ doctrine developed in the line of cases starting with Halifax Plc v Customs & Excise Commissioners [2006] STC 919, ECJ.

The position of the buyer 8.26 The acquisition by the buyer company of the shares of Target is not itself the making of a supply by the buyer: it is an acquisition. Nor is the buyer’s issue of shares or securities a supply by it. It was held in Kretztechnik AG v Finanzamt Linz [2005] STC 1118, ECJ, that the issue of shares by a company for the purposes of raising capital was not a supply by the company. HMRC has accepted that this extends to the issue of securities, as well as shares, and to the issue of shares or securities in exchange for shares, in other words to the sort of takeover that is discussed in this chapter: Business Brief 21/05, 23 November 2005. The main question, as usual, is whether the buyer can obtain a refund of its input VAT on the professional fees and other costs which it incurs for the purpose of the purchase. The first question is whether the buyer is carrying on a relevant business for VAT at all. If it is not – if, for example, it is and is to be a pure holding company as regards Target, see 3.6 – it cannot obtain a refund of any input VAT. It might be that the company carries on a mixture of business and non-business activities, for example it may manufacture widgets but also act as a passive holding company: if so the input VAT must be apportioned between them depending on the purpose of the purchase (normally not under any specific provisions of the VAT Regulations 1995 but on general principles), and any input VAT apportionable to the non-business activities will not be recoverable: Securenta Göttinger v Finanzamt Göttingen [2008] STC 3473, ECJ. If Target is to be held as a passive investment (see 3.7), it will be irrecoverable. The Court of Appeal case of BAA Limited v Revenue & Customs Commissioners [2011] STC 1791, UT, [2013] STC 752, CA, is an awful warning as to what can happen if VAT planning is neglected when a company is being bought. It arose out of the acquisition in 2006 of BAA plc by the Spanish group Ferrovial. Ferrovial set up an SPV (later renamed BAA Limited, the appellant) to make the purchase. The SPV did not attempt to register for VAT. The SPV ran up no less than £6.7m of input VAT on professional fees and other costs in connection with the intended acquisition. The acquisition took place, and shortly afterwards the SPV joined the BAA plc VAT group. The court held that the SPV was not entitled to a refund of its input VAT. This was because: ●●

the recoverability of VAT on inward supplies has to be decided at the date on which the inward supply is made; 230

Share-for-share exchanges 8.26 ●●

at that point the SPV was not for carrying on a business for VAT purposes (‘economic activity’, to use the EU term) at all. This was because there was no evidence that it intended, if the acquisition went through, to render any taxable management services to BAA plc or make any other taxable supplies. While a company which carries out preparatory activities for a new taxable business and sets up a successor which actually makes the taxable supplies can itself register for VAT and recover its input VAT (Finanzamt Offenbach am Main-Land v Faxworld Vorgründungsgesellschaft Peter Hünningshausen und Wolfgang Klein GbR [2005] STC 1192, ECJ), that was not the situation: the SPV was simply incurring expenses in order to buy BAA plc, which was already carrying on its business.

A person who is not carrying on a business can never recover input VAT, so that was enough for the court to dismiss the appeal. However the court went on to hold that in any event there was no direct and immediate link (one of the tests for input VAT recovery) between the inward supplies to the SPV and BAA plc’s own supplies after acquisition. The SPV’s input VAT was irrecoverable. Before the Upper Tribunal (the point was not pursued before the Court of Appeal) the SPV sought to invoke VAT Regulations 1995, reg 111, under which an unregistered person who runs up input VAT on services within the six months before being registered can, subject to various rules, obtain a refund of it. This was unsuccessful: the Tribunal held that VAT Regulations 1995, reg 111 only gets you over the fact of non-registration, it is still necessary to show that the input VAT was run up in the course of a business and that the expense in question was incurred for the purpose of making taxable supplies. What should the SPV have done? ●●

The ideal solution from the VAT point of view, if Target’s business is taxable, is for the SPV to resolve at the outset that, if the purchase is successful, Target will hive its business up to the SPV immediately after; and to actually do so if the bid is successful. The input VAT will then be run up for the purposes of the taxable supplies that the buyer will make in the course of that business: Customs & Excise Commissioners v UBAF Bank Limited [1996] STC 372, CA. However, it is unlikely that a buyer will be prepared to do this for input VAT recovery reasons only, and it should consider whether it fits in with its plans from the commercial and direct tax points of view.

●●

Failing that, though slightly less reliable, is for the buyer to resolve, at the outset, that, if the bid is successful, it will render management or marketing services or the like to Target for an arm’s-length (standardrated) fee. The fee, or a formula for calculating it, should be specified 231

8.26 Share-for-share exchanges in some detail (see ‘the Consideration Point’ at 3.7) – a vague intention to charge a fee is not enough. Ideally the SPV would, before the acquisition takes place, enter into a contract with Target for the provision of management services, conditional on legal completion taking place, though this is rather a counsel of perfection. If the acquisition takes place the buyer should, of course, render the services and charge the fees. In all cases there should be contemporaneous evidence of these resolutions, for example, in board minutes. If one of these measures is taken, and would work if the purchase took place, the buyer will still be entitled to a refund of the input VAT even if the bid is abortive: Belgium v Ghent Coal Terminal NV [1998] STC 260, ECJ. There are dicta in BAA before the Upper Tribunal which suggest that it may be enough for the buyer to merely resolve, at the outset, that, if the bid is successful and a VAT group would be making taxable supplies, it will VAT group with Target (and do so if the bid is successful). The idea is that the input VAT would then be run up for the purpose of the taxable supplies that the VAT group would be making. The Court of Appeal did not discuss this but it does not square with its ratio decidendi, and it should not be relied on. The question remains, if one of the bullet-pointed routes is being taken, does VAT grouping with Target when acquired help? Or hinder? If the first route (hive-up) is taken it neither helps nor hinders as regards the recovery of input VAT on acquisition costs, and VAT grouping can be done if desired for other reasons. If the second bullet-pointed course is taken, while VAT grouping would probably do no harm, the safest course is not to VAT group and for the buyer to render the management services to its new, ungrouped, subsidiary. If grouping is desired for other reasons it is suggested that the buyer should wait until, say, six months has elapsed. Having said all that, we must alert readers to the fact that HMRC’s apparent policy is to take a very restrictive line on the recovery of input VAT on acquisition costs in ‘management services’ cases – that is, where the buyer is relying on the fact that he will be rendering management services to Target. It is explained in VAT Input Tax Manual paras VIT 40100, 40500 and 40600. Essentially they now take the view that the input VAT can be recovered provided that the company is making management charges and now takes into account the cases of Cibo Participations SA v Directeur régional des impôts du Nord-Pas-de-Calais [2002] STC 460, ECJ, and Beteiligungsgesellschaft Larentia + Minerva mbH & Co KG v Finanzamt Nordhausen [2015] STC 2101,ECJ, which clearly lay down that acquisition costs are part of a buyer’s general expenditure and (so long as the buyer is carrying on a taxable business in relation to the shares) do not need to be matched with receipts.

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Share-for-share exchanges 8.28

The position of the buyer: registration 8.27 A buyer company which is not already registered and which is using one of the two bullet point methods above should apply for (voluntary) registration, as an intending trader, as soon as it makes the resolution in question and before the tax point of any of the inward supplies. If that is not done, it is possible to apply for retrospective registration later, but HMRC have a discretion here and it is much better not to rely on that. If it delays registration and registers but not retrospectively, it is possible to apply under VAT Regulations 1995, reg 111 (see above) for a refund of pre-registration input VAT incurred on services in the six months before registration, but again HMRC seem to have a discretion and it is far better not to rely on that. An early application for registration in practice is valuable evidence in itself that the buyer intends from the start to carry on a taxable business.

The position of the buyer: expenses incurred in another company 8.28 In practice, what often happens is that the contracts with advisers are entered into by an existing company (X Limited) in the buyer organisation, and only later is a different company, the SPV, set up to make the purchase. This may be either because the initial idea is that X Limited should make the purchase and later the organisation changes its mind, or simply that at the outset the buyer organisation has not got round to setting up the SPV. In these circumstances: ●●

if the initial intention is that X Limited should make the purchase, and later the organisation changes its mind, X Limited should proceed as in 8.26 and 8.27 above. When SPV is set up there should be a written assignment by X Limited of the benefit of the contracts, and any reports and written advice generated by them, to SPV for a (standard-rated) fee equal to the amount that X Limited has incurred. X Limited should then be entitled to recover the input VAT on its costs and SPV should be entitled to recover the input VAT on the fee;

●●

if it is simply that the buyer organisation has not got round at the outset to setting up SPV, X Limited should resolve at the outset, for example by way of a board minute, that it is incurring these expenses with a view to assigning the benefit of the contracts and the advice generated etc to SPV when it is set up. When SPV is set up the parties should proceed as set out in the first bullet point and the VAT consequences should be the same.

What one is trying to guard against are arguments by HMRC either that X Limited never intends to carry out any kind of business in relation to the 233

8.29 Share-for-share exchanges shares in Target; or that the reimbursement is a pure recharge, with X Limited rendering no supply to SPV for VAT. In some acquisitions, more than one SPV is set up. For example, there can be three SPVs in a corporate group, SPV1 buying the shares in Target, SPV2 borrowing senior debt and SPV3 borrowing mezzanine debt. SPV2 and SPV3 may lend direct to Target or may lend to SPV1 to finance its acquisition. Separate engagement letters should be entered into by the separate companies, each running up the fees appropriate to its activity: this may involve an adviser having to apportion between the SPVs what would otherwise be a global fee. Where SPV2 and SPV3 will be lending on to Target at interest (exempt supplies), there is a temptation to load the fees in favour of SPV1, if that will be making taxable supplies, but to overdo this would make it liable to challenge.

The position of Target 8.29 Target, of course, plays an essentially passive role in the takeover. It should incur little or no input VAT for the purpose of the takeover, but there will sometimes be some scope for Target to legitimately incur some expenses, for example, for the purpose of providing answers to some of the buyer’s due diligence enquiries, or in making a clearance application (see 14.21). Any such input VAT should be residual overhead input VAT of Target.

The position of the buyer: a hive-up 8.30 Not infrequently, immediately after the purchase Target hives its business up to the Buyer. Indeed, as we have seen (at 8.26) this can be a good thing to do as regards the Buyer’s input VAT recovery on his general costs of purchase (though it will be uncommon for a Buyer to carry out a hive-up for VAT planning reasons alone). If the companies are already in a VAT group the transfer will, of course, be a non-event for VAT. If they are not in a VAT group, the hive-up will generally be a transfer of a business as a going concern (‘TOGC’), and therefore outside the scope of VAT. The TOGC rules are in VAT (Special Provisions) Order 1995, SI 1995/1268, art 5(1)–(3) and are explained in more detail in Chapter 3 at 3.12 and 3.13. Additional rules apply where interests in land or buildings are included in the transfer, as explained there. The costs of the exercise if incurred by Target are general overhead costs of its business, and if incurred by the Buyer relate to the business being acquired: in either case, therefore, if that business is fully taxable for VAT the input VAT on those costs is fully recoverable by the company which incurs them. 234

Share-for-share exchanges 8.30 If the Buyer is in a VAT group, but Target is not in it, and the business being transferred is not a fully taxable one, there is a trap: VATA 1994, s 44 says that on acquisition of the business by way of a TOGC, the acquirer, the Buyer here, makes for VAT purposes a deemed disposal and reacquisition of some of the assets of the business immediately after acquiring them. Therefore, the Buyer will have to pay output VAT on this deemed disposal, but will be entitled only to a limited, or nil, refund of input VAT on the reacquisition, because the business is wholly or partially exempt. Where this rule is in point buyers and their advisers need to study VATA 1994, s 44 and what HMRC have published about it in VAT Notice 700/9/18 at paragraphs 5.2 to 5.4.

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Chapter 9

Exchanges involving qualifying corporate bonds

INTRODUCTION 9.1 A special regime is required for the conversion of shares or other securities into qualifying corporate bonds (‘QCBs’). This is because a gain arising on the disposal of a QCB is not a chargeable gain under TCGA 1992, s 115 (which also provides the same treatment to gilt-edged securities). Clearly, in the absence of specific rules, shares standing at a large gain could be converted (actually or by exchange) into QCBs, which would then be exempt from tax. Therefore, any future disposal of the QCB would, in effect, represent a tax-free disposal of the original shares.

WHAT IS A QCB? 9.2 QCBs are defined at TCGA 1992, s 117. The basic definition for the purposes of corporation tax is at TCGA 1992, s 117(A1): ‘For the purposes of corporation tax ‘qualifying corporate bond’ means any asset representing a loan relationship of a company; and for purposes other than those of corporation tax references to a qualifying corporate bond shall be construed in accordance with the following provisions of this section.’ TCGA 1992, s 117(2)–(6C) then go on to define a ‘corporate bond’ for purposes other than corporation tax and TCGA 1992, s 117(7) tells us that a QCB is a corporate bond that was issued after 13 March 1984. Broadly speaking, a corporate bond is a security as defined in TCGA 1992, s 132(3)(b) – which, as we have seen (Chapter 7), is no definition at all – that has at all times represented a normal commercial loan (as defined by CTA 2010, Part 5, Chapter 6) and which is expressed in sterling with no provision made for 236

Exchanges involving qualifying corporate bonds 9.4 conversion or redemption into any other currency. Generally, a non-convertible debenture denominated in sterling and issued on normal commercial terms will be a QCB. The important issue here is that the status of an instrument as a QCB depends partly on the holder: as we saw above, ‘any asset representing a loan relationship of a company’ is a QCB, so any security issued in a reorganisation or deemed reorganisation will be a QCB if it is issued to a company. If it is issued to an individual, the status of an instrument as a QCB or not, will depend on its terms. This is important, as individuals will often prefer to hold non-QCBs to ensure that they are only subject to capital gains tax on the proceeds that they receive. The regime for QCBs, as we shall see, crystallises a liability when the QCBs are received, so that capital gains tax may become payable, even if the cash proceeds are never received by the taxpayer.

HOW TO MAKE A NON-QCB 9.3 There are two common methods of ensuring that the loan notes do not constitute QCBs, either by making sure that the notes are not ‘normal commercial loan’ as defined in CTA 2010, Part 5, Chapter 6, or by adding a currency conversion clause.

Normal commercial loan 9.4 CTA 2010, s 162 states that a ‘normal commercial loan’ must satisfy a number of criteria. One of these is that the loan should not carry any right to conversion into shares or securities (CTA 2010, s 162(2)) and another is that the loan should not carry any right to acquire shares or securities (CTA 2010, s 162(3)). So one method of ensuring that a loan note is a non-QCB is to incorporate a provision into the loan note instruments enabling the holder to subscribe for additional shares or securities, which would mean that the QCBs do not represent a ‘normal commercial loan’ as defined by CTA 2010, s 162. It is worth noting that the Taxation of Regulatory Capital Regulations 2013 (SI 2013/3209) repealed the extension of the definition of a ‘normal commercial loan’ to loans that form part of the Tier 2 capital for banks. This was dealt with by SI 2013/3209, reg 4 which stated that a regulatory capital security represents a normal commercial loan. SI 2013/3209 was repealed as part of the ‘hybrid capital instrument’ legislation introduced by FA 2019. Therefore, in certain circumstances, a regulatory capital security might now be a normal commercial loan (and therefore a QCB) for individuals, although in practice the likelihood of an individual holding Tier 2 capital in a bank is small. 237

9.5 Exchanges involving qualifying corporate bonds

Currency conversion 9.5 As noted above, a QCB must be expressed in sterling with no provision made for conversion or redemption into any other currency (TCGA 1992, s 117(1)(b)). However, if redemption is permitted in another currency, but only at the rate prevailing at the date of redemption, the loan note is still a QCB (TCGA 1992, s 117(2)(b)), in effect because there is no manipulation of exchange rates in that scenario. One way to ensure that a bond is a non-QCB therefore is to incorporate a provision into the loan note instruments enabling them to be converted into a currency other than sterling at a date prior to the redemption date, which would mean that the loan note fails the condition of TCGA 1992, s 117(1)(b) that it be expressed and redeemable in sterling. In recent years, it has been common for the loan notes to be issued on terms that permit conversion into or redemption in Euros. This may be a slightly riskier option, following the 2014 case of Trigg v Revenue and Customs Commissioners [2014] UKFTT 967 (TC), where bonds with a euro conversion clause were held by the First-tier Tribunal to be QCBs, nevertheless. It should be noted that, in this case, the taxpayer was seeking QCB treatment, as he and his partners had acquired the bonds on the specific basis that they were QCBs, so that any profit on disposal would be exempt from capital gains tax1. The main reasoning behind the judgment was that the bonds were convertible into euros if the UK joined the Eurozone. Therefore, the ‘rate’ between pounds sterling and Euros would be fixed when the UK joined the Eurozone, and TCGA 1992, s 117(2)(b) would apply, using a purposive interpretation, as the eventual redemption in Euros would have had its rate fixed on conversion. The decision was appealed and the Upper Tribunal ([2016] UKUT 165 (TCC)) reversed the decision, on the basis that ‘sterling’ means the lawful currency of the UK for the purposes of TCGA 1992, s 117(1)(b) and could not be interpreted as any future lawful currency of the UK. The Court of Appeal ([2018] EWCA Civ 17) reversed the Upper Tribunal’s decision on the grounds that the bond documents did not make provision for a conversion of the bonds. It was assumed, instead, that they would become Eurobonds by operation of law, not by any specific process of conversion. Since TCGA 1992, s 117(1)(b) requires there to be provision for the conversion of the bonds, the lack of such a provision means that they are QCBs, not non-QCBs. For now, we are nevertheless advising clients to use currencies other than Euros for this purpose.

1 This rather begs the question as to whether buying and selling the bonds should have been subject to income tax, as a trading venture, in any case.

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Exchanges involving qualifying corporate bonds 9.7

THE LEGISLATION 9.6 Not surprisingly, the regime for QCBs in TCGA 1992, s 116 is similar in concept to the regime for gilt-edged securities in TCGA 1992, s 134 (since gains on both QCBs and gilts are not chargeable gains). However, the scope of the regime for QCBs is generally wider than that for gilts as the scope for other transactions involving QCBs, such as conversions or exchanges, is much wider than that for gilts. Very broadly, if the original holding consists of QCBs, the exchange, conversion or reorganisation is treated as a disposal of the QCBs – exempt under TCGA 1992, s 115 – and the shares or debentures issued in the transaction are treated as being acquired, ie the reorganisation provisions are not in point. If, on the other hand, shares or non-QCB debentures are exchanged for or converted into QCBs, the original securities are treated as not having been disposed of, but the gain that would otherwise have accrued at the time of the exchange is held over. That gain then crystallises on a subsequent disposal of the QCB. Let us review the legislation in detail. TCGA 1992, s 116(1) and (2) – scope of provision 9.7 ‘(1) This section shall have effect in any case where a transaction occurs of such a description that, apart from the provisions of this section – (a) sections 127 to 130 would apply by virtue of any provision of Chapter II of this Part; and (b) either the original shares would consist of or include a qualifying corporate bond and the new holding would not, or the original shares would not and the new holding would consist of or include such a bond; and in paragraph (b) above “the original shares” and “the new holding” have the same meaning as they have for the purposes of sections 127 to 130. (2) In this section references to a transaction include references to any conversion of securities (whether or not effected by a transaction) within the meaning of section 132 and “relevant transaction” means a reorganisation, conversion of securities or other transaction such as is mentioned in subsection (1) above, and, in addition to its application where the transaction takes place after the coming into force of this 239

9.8 Exchanges involving qualifying corporate bonds section, subsection (10) below applies where the relevant transaction took place before the coming into force of this section so far as may be necessary to enable any gain or loss deferred under paragraph 10 of Schedule 13 to the Finance Act 1984 to be taken into account on a subsequent disposal.’ Analysis 9.8 This provision sets out the terms of reference of TCGA 1992, s 116. It covers any transaction to which TCGA 1992, ss 127–131 apply, so it encompasses reorganisations of capital, conversions of securities, exchanges brought within the reorganisation provisions by TCGA 1992, s 135 and reconstructions brought within those provisions by TCGA 1992, s 136. It is interesting that TCGA 1992, s 116(2) specifically has to bring conversions of securities into the scope of TCGA 1992, s 116, as TCGA 1992, s 132(1) appears to us to be a ‘provision of Chapter II of this Part’ and so within the scope of TCGA 1992, s 116(1)(a) already. TCGA 1992, s 116 applies to any such transaction where any part of either the original shares or the new holding constitutes a QCB. Harding v HMRC 9.9 As mentioned briefly in Chapter 7, the concept of a conversion without a transaction arose from the case of Harding v HMRC SpC 608, [2008] All ER (D) 265 and [2008] EWCA Civ 1164. Mr Harding sold some shares and claimed to roll over the gains into a bond that was structured not to be a QCB. As the bond, when issued, was not a QCB, the gain was rolled over instead, so that no chargeable event occurred until redemption or disposal of the bond. However, the feature that prevented the bond being a QCB expired before redemption and Mr Harding claimed that the bond was therefore a QCB when it was redeemed. On that analysis, since the disposal of a QCB is outside the scope of capital gains tax, by TCGA 1992, s 115, Mr Harding claimed that no gain was assessable on him. Had the event that changed the nature of the QCB been a transaction, this would have been a conversion within TCGA 1992, s 132, which would have brought TCGA 1992, s 116 into effect, so that the gain on the QCB (including the gain on the original shares) would have crystallised at the time of the conversion. The gain would then have been held over (or ‘frozen’, as the Special Commissioner put it) into the QCB until it was redeemed or disposed of, when the gain would come into charge by the operation of TCGA 1992, s 116(10)(a), (b). Mr Harding argued that the expiry of the relevant clause in the terms of the loan notes was a change in its nature without a transaction, as the lapse of the 240

Exchanges involving qualifying corporate bonds 9.10 relevant terms was inherent in the security itself, so that neither TCGA 1992, s 132 nor TCGA 1992, s 116 could apply, as both required a transaction (before they were amended). This apparent lacuna in the legislation was amended by FA 1997, so that both TCGA 1992, ss 132 and 116 now define a conversion as including something ‘effected by a transaction or in consequence of the operation of the terms’ of a security. And TCGA 1992, s 116 now specifically applies to conversions of securities even if they are ‘not effected by a transaction’. The courts found against Mr Harding, in any case, finding that the loan note remained a non-QCB until redemption, notwithstanding the expiry of the relevant clause. The decisions are based largely on a finding by the Special Commissioner that the relevant clause remains a term of issue of the security, even if it has now lapsed in effect. This approach ‘focuses on the formal terms of the security rather than those which are effective at any particular time’ and was largely echoed in the Court of Appeal. A more purposive approach was taken in the High Court, where the judge, Briggs J, said ‘I find it impossible to believe that the draftsman who framed the [TCGA 1992, s 117(1)(b)] condition, or Parliament when it passed it, consciously intended to [give the result which a literal interpretation of the words used would give]’. So the change made in 1997 was arguably an unnecessary precaution. It is also interesting to note that the relevant provisions of the loan note were not disclosed when Mr Harding applied to the Inland Revenue for pre-transaction clearance under TCGA 1992, s 138. This is discussed further in Chapter 14. Anthony Hancock and Tracy Lee Hancock 9.10 This is a more recent case ([2014] UKFTT 695 (TC)) about the requirements of TCGA 1992, s 116(1)(b). The Hancocks managed to manipulate their holdings of a mixture of QCBs and non-QCBs. Mr and Mrs Hancock received a mixture of non-QCB loan notes when they sold their company. This was a deemed reorganisation by virtue of TCGA 1992, s 135 (Chapter 8). They converted some of the loan notes into QCBs, using a deed of variation. This is a conversion of securities by virtue of TCGA 1992, s 132 (Chapter 7). The entire holding of securities was then converted into another form of QCB, after which all the QCBs were redeemed. Mr and Mrs Hancock successfully argued (at the FTT) that the conversion of the mixed QCB and non-QCB holding was not within TCGA 1992, s 116, as TCGA 1992, s 116(1)(b) requires either that the original holding be or include QCBs and the new holding not, or vice versa. Since both holdings included QCBs, TCGA 1992, s 116 could not apply. As a result, the conversion of the mixed QCB and non-QCB holding was simply a tax-free conversion to which TCGA 1992, s 132 applied, and the 241

9.11 Exchanges involving qualifying corporate bonds eventual redemption of the new QCBs was outside the scope of capital gains tax, by virtue of TCGA 1992, s 115. The Upper Tribunal ([2016] UKUT 81 (TCC)) reversed this decision, on the grounds that the word ‘transaction’ in TCGA 1992, s 116(1) could not encompass more than one conversion of securities. The subsequent redemption of the notes crystallised the latent gain. The Court of Appeal ([2017] EWCA Civ 198) dismissed the taxpayers’ appeal, saying that the reorganisation provisions required shares to be converted into shares or debentures rather than having QCBs on the ‘input’ side. In addition, the deeming by TCGA 1992, s 132(1) could not go as far as amalgamating instruments of different classes which have different tax treatments. Instead, it was necessary to treat the transaction as two separate conversions. In doing so, the Court of Appeal applied a purposive interpretation of the reorganisation provisions. In the Supreme Court ([2019] 1 WLR 3409), the taxpayers’ appeal was again dismissed. In their judgment, the Supreme Court entirely ignored the phrase ‘or include’ in TCGA 1992, s 116(1)(b) and rendered it otiose on the basis that to respect it would be to run counter to Parliament’s original intentions in implementing TCGA 1992, s 132. This case, and in particular the Supreme Court judgment, highlights the point around needing to read legislation with an appreciation of the wider context in which it has been implemented. In practice, we often find ourselves revisiting materials from the time legislation is introduced to consider the derivation of statutory provisions, especially where the language used in the particular provision in question is ambiguous. The Supreme Court judgment in Hancock highlights the need to do so in certain circumstances. There is a twofold aspect to this research, as it is necessary both to understand the underlying purpose of the legislation when it was first introduced, and then to interpret how that purpose would be applied in a contemporary judicial process on the facts of the case in hand. TCGA 1992, s 116(3) and (4) – definitions 9.11 ‘(3) Where the qualifying corporate bond referred to in subsection (1)(b) above would constitute the original shares for the purposes of sections 127 to 130, it is in this section referred to as “the old asset” and the shares or securities which would constitute the new holding for those purposes are referred to as “the new asset”. (4) Where the qualifying corporate bond referred to in subsection (1)(b) above would constitute the new holding for the purposes of sections 127 to 130, it is in this section referred to as “the new asset” and the shares or securities which would constitute the original shares for those purposes are referred to as “the old asset”.’ 242

Exchanges involving qualifying corporate bonds 9.16 Analysis 9.12 These subsections define terms for use later on in TCGA 1992, s 116. They translate the terminology of TCGA 1992, ss 127–130 into a different set of terms, to apply a similar methodology of deeming certain assets to exist to a rather different charging mechanism. TCGA 1992, s 116(4A) – definitions 9.13 ‘(4A) In determining for the purposes of subsections (1) to (4) above, as they apply for the purposes of corporation tax – (a) whether sections 127 to 130 would apply in any case, and (b) what, in a case where they would apply, would constitute the original shares and the new holding, it shall be assumed that every asset representing a loan relationship of a company is a security within the meaning of section 132.’ Analysis 9.14 This provision was introduced with FA 1996 as part of the loan relationships regime, now in CTA 2009, Part 5. It is intended to ensure that all loan relationships are subject to TCGA 1992, s 116, even if they do not constitute a debenture or security. TCGA 1992, s 116(5) and (6) – disapplication of the reorganisation provisions 9.15 ‘(5) So far as the relevant transaction relates to the old asset and the new asset, sections 127 to 130 shall not apply in relation to it. (6) In accordance with subsection (5) above, the new asset shall not be treated as having been acquired on any date other than the date of the relevant transaction or, subject to subsections (7) and (8) below, for any consideration other than the market value of the old asset as determined immediately before that transaction.’ Analysis 9.16 TCGA 1992, s 116(5) is key as it is the provision that disapplies the reorganisation provisions from any transaction which involves a QCB.

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9.17 Exchanges involving qualifying corporate bonds TCGA 1992, s 116(6) then puts the extent of the disapplication beyond doubt. It tells us that any ‘new assets’, being the assets acquired in the reorganisation transaction (see TCGA 1992, s 116(3), (4)), are treated as having been acquired on the date of the transaction – not on the earlier date when the old asset was acquired – and the cost is deemed to be the market value of the old asset (ie the consideration given for the new asset) rather than the original cost of the old asset. So we have a belt-and-braces approach here; first, we are told that the reorganisation provisions do not apply, then we are told that the effects that those provisions would have had, had they applied, will not be in point because those provisions do not apply! TCGA 1992, s 116(7) – consideration received 9.17 ‘(7) If, on the relevant transaction, the person concerned receives, or becomes entitled to receive, any sum of money which, in addition to the new asset, is by way of consideration for the old asset, that sum shall be deducted from the consideration referred to in subsection (6) above.’ Analysis 9.18 This provision ensures that if a person receives cash as well as shares or debentures in a transaction, that amount is deducted from the deemed cost of the new asset. This is completely logical. The vendor has disposed of an asset worth £X for consideration with a total value of £X. If he receives £Y in cash, the deemed cost of the new asset must be £(X − Y). The cash is ordinary consideration, which one might imagine would be charged to tax immediately under normal principles. However, there is a slightly more complex approach detailed in TCGA 1992, s 116(12)–(14) below. TCGA 1992, s 116(8) – consideration given 9.19 ‘(8) If, on the relevant transaction, the person concerned gives any sum of money which, in addition to the old asset, is by way of consideration for the new asset, that sum shall be added to the consideration referred to in subsection (6) above.’ Analysis 9.20 This is the reverse of the provision in TCGA 1992, s 116(7). If a person sells an asset and also pays some cash for the new asset, it is axiomatic that the total cost of the new asset should be the market value of the old asset plus the cash consideration given. 244

Exchanges involving qualifying corporate bonds 9.21 TCGA 1992, s 116(8A) and (8B) – interaction with loan relationships1 9.21 ‘(8A)

Where subsection (6) above applies for the purposes of corporation tax in a case where the old asset consists of a qualifying corporate bond, Part 5 of CTA 2009 (loan relationships) shall have effect, subject to subsection (8B) below, so as to require such debits and credits to be brought into account for the purposes of that Part in relation to the relevant transaction as would have been brought into account if the transaction had been a disposal of the old asset at the market value mentioned in subsection (6) above. This subsection does not apply in relation to relevant loan relationship transaction.

(8AA) In subsection (8A) “relevant loan relationship transaction” means a transaction to which any of the following provisions applies–

section 342 of CTA 2009 (continuity of treatment on transfers within groups or reorganisations: issues of new securities on reorganisations: disposal at notional carrying value),

section 343 of that Act (continuity of treatment on transfers within groups or reorganisations: receiving company using fair value accounting),

section 424 of that Act (European cross-border transfers of business: reorganisations involving loan relationships),

section 425 of that Act (European cross-border transfers of business: original holder using fair value accounting),

section 435 of that Act (European cross-border mergers: reorganisations involving loan relationships),

section 436 of that Act (European cross-border mergers: original holder using fair value accounting).

(8B)

Subsection (8A) above does not apply where the relevant transaction is a conversion of securities occurring in consequence of the operation of the terms of any security or of any debenture which is not a security.

Expressions used in this subsection have the same meaning as they have for the purposes of section 132.’

1 TCGA 1992, s 116(8A), (8B) were initially repealed by SI 2007/3186, enacting the EU Mergers Directive, and the equivalent provisions were moved to the loan relationships legislation in FA 1996 (now moved to CTA 2009, Part 5). However, there was some doubt as to whether this repeal was lawful, as this might have gone beyond the powers granted by FA 2007, s 110 (see Chapter 18). SI 2008/1579 revoked the repeal in SI 2007/3186 but added the final sentence of TCGA 1992, s 116(8A). The legislation has now been expanded to include TCGA 1992, s 116(8AA), following the rewrite of the loan relationships legislation to CTA 2009, Part 5.

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9.22 Exchanges involving qualifying corporate bonds Analysis 9.22 The main point of TCGA 1992, s 116(8A) is to ensure that a disposal of an old asset that is a QCB will be properly taken into account under the loan relationship rules, which is the regime under which QCBs are normally taxed (and which is why they are exempt from capital gains tax). So when the QCB is converted into a non-QCB, the disposal proceeds for the loan relationships rules is the market value of the QCB. The new asset then comes into the capital gains regime, presumably at market value as well by virtue of TCGA 1992, s 116(6). The provisions mentioned in TCGA 1992, s 116(8AA) were introduced to ensure that the loan relationships legislation was compliant with the Mergers Directive (and was introduced by SI 2007/3186, then largely rewritten by SI 2008/1579). If relief is granted under any of these provisions, TCGA 1992, s 116(8A) needs to be disapplied, to prevent that relief being effectively overridden. The exclusion in TCGA 1992, s 116(8B) takes convertible QCBs out of the scope of TCGA 1992, s 116(8A). This is because under both UK GAAP and IAS convertible bonds are treated as loans with embedded derivatives (being the conversion right) and the accounting treatment is to bifurcate the two elements and tax the derivative element under CTA 2009, Part 7. The rule under TCGA 1992, s 116(8A) would give the wrong result in that case, so it is disapplied for convertible QCBs for conversions on or after 26 May 2005. TCGA 1992, s 116(9) – old asset is a QCB 9.23 ‘(9) In any case where the old asset consists of a qualifying corporate bond, then, so far as it relates to the old asset and the new asset, the relevant transaction shall be treated for the purposes of this Act as disposal of the old asset and an acquisition of the new asset.’ Analysis 9.24 This is another iteration of the implications of a relevant transaction where the old asset is a QCB. Where the old asset is a QCB, we are told that the transaction shall be treated as a disposal of the old asset – tax-free under TCGA 1992, s 115, of course, but chargeable under the FA 1996 regime by virtue of TCGA 1992, s 116(8A) above – and an acquisition of the new asset. So the no-disposal fiction and the single composite asset fiction do not apply in these circumstances.

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Exchanges involving qualifying corporate bonds 9.26 TCGA 1992, s 116(10) – new asset is a QCB 9.25 ‘(10) Except in a case falling within subsection (9) above, so far as it relates to the old asset and the new asset, the relevant transaction shall be treated for the purposes of this Act as not involving any disposal of the old asset but – (a) there shall be calculated the chargeable gain or allowable loss that would have accrued if, at the time of the relevant transaction the old asset had been disposed of for a consideration equal to is market value immediately before that transaction; and (b) subject to subsections (12) to (14) below, the whole or a corresponding part of the chargeable gain or allowable loss mentioned in paragraph (a) above shall be deemed to accrue on a subsequent disposal of the whole or part of the new asset (in addition to any gain or loss that actually accrues on that disposal); and (c)

on that subsequent disposal, section 115 shall have effect only in relation to any gain or loss that actually accrues and not in relation to any gain or loss which is deemed to accrue by virtue of paragraph (b) above.’

Analysis 9.26 This is the basic provision that applies when the new asset is a QCB and it is clearly similar in operation to TCGA 1992, s 134 which applies to gilt-edged securities. We are told that the transaction is not to be treated as a disposal of the old (non-QCB) asset, but that the gain or loss that would have accrued on a market value disposal must be calculated. That gain (or loss) then comes into charge when there is an actual disposal of the QCB. If only part of the QCB holding is disposed of, then an appropriate part of the gain or loss is deemed to accrue. One vital point here is that ‘disposal’ is wider in meaning than just a sale. In particular, redemption or waiving of the security will also constitute a disposal in this context. This is important to remember, particularly in the context of group reorganisations, as otherwise gains can accrue unexpectedly through the operation of TCGA 1992, s 116(10)(b). Finally, we are reminded that the provisions of TCGA 1992, s 116(10) only apply to gains held over in the relevant transaction. So if the QCB increases or decreases in value before eventual disposal, that increase or decrease is outside 247

9.27 Exchanges involving qualifying corporate bonds the scope of capital gains tax by virtue of TCGA 1992, s 115. The only gain (or loss) that accrues under TCGA 1992, s 116(10) is that which arose on the original shares/old asset in relation to the relevant transaction. TCGA 1992, s 116(11) – exemptions 9.27 ‘(11) Subsection (10)(b) and (c) above shall not apply to any disposal falling within section 58(1), 62(4), 139, 140A, 140E or 171(1), but a person who has acquired the new asset on a disposal falling within any of those sections (and without there having been a previous disposal not falling within any of those sections or a devolution on death) shall be treated for the purposes of subsection (10)(b) and (c) above as if the new asset had been acquired by him at the same time and for the same consideration as, having regard to subsections (5) to (8) above, it was acquired by the person making the disposal.’ Analysis 9.28 This provision ensures that the standard tax-exempt transfer provisions do not cause a TCGA 1992, s 116(10)(a) rolled over gain to crystallise. Those provisions are husband and wife transfers (TCGA 1992, s 58(1)), transfers to a legatee on death (TCGA 1992, s 62(4)) and intra-group transfers between UK resident companies (TCGA 1992, s 171(1)), as found in TCGA 1992, s 134(4), as well as the incorporation of a UK permanent establishment of a company resident in another Member State (TCGA 1992, s 140A) and a merger to form a company which is UK resident or has a UK permanent establishment (TCGA 1992, s 140E). In each of these cases, however, the recipient under any of these provisions will suffer the held over tax charge on the eventual disposal of the securities. TCGA 1992, s 116(12) to (14) – taxation of consideration received 9.29 ‘(12) In any case where – (a) on the calculation under subsection (10)(a) above, a chargeable gain would have accrued; and (b) the consideration for the old asset includes such a sum of money as is referred to in subsection (7) above; then, subject to subsection (13) below, the proportion of that chargeable gain which that sum of money bears to the market value of the old asset 248

Exchanges involving qualifying corporate bonds 9.30 immediately before the relevant transaction shall be deemed to accrue at the time of that transaction. (13) If the sum of money referred to in subsection (12)(b) above is small, as compared with the market value of the old asset immediately before the relevant transaction, subsection (12) above shall not apply. (14) In a case where subsection (12) above applies, the chargeable gain which, apart from that subsection, would by virtue of subsection (10)(b) above be deemed to accrue on a subsequent disposal of the whole or part of the new asset shall be reduced or, as the case may be, extinguished by deducting therefrom the amount of the chargeable gain which, by virtue of subsection (12) above, is deemed to accrue at the time of the relevant transaction.’ Analysis 9.30 TCGA 1992, s 116(12) provides for an immediate charge to tax when consideration is received as part of the disposal proceeds in a relevant transaction, as described in TCGA 1992, s 116(7). Instead of charging the proceeds as a part disposal of the old asset, the amount charged is the proportion of the chargeable gain computed under TCGA 1992, s 116(10)(a) represented by the cash consideration received as compared to the market value of the old asset. So, for example, if the cash represents half the value of the old asset, half the chargeable gain is chargeable immediately under TCGA 1992, s 116(12) and the other half is rolled over to come into charge as required by TCGA 1992, s 116(10)(b). The effect of TCGA 1992, s 116(14) is to ensure that there is no double charge. If the QCBs are disposed of in a single transaction, the effect is clear, and the gain that would have come into charge under TCGA 1992, s 116(10)(b) is reduced by the amount of gain already charged under TCGA 1992, s 116(12). If the QCBs are disposed of in tranches (as in Example 9.2), we believe that TCGA 1992, s 116(14) operates to reduce each gain accruing under TCGA 1992, s 116(10)(b) to nil, until the gain under TCGA 1992, s 116(12) has been ‘used up’. However, if the cash receipt is small in comparison to the market value of the old asset, this provision is not applied, ‘to avoid the delay and expense of a full computation where this would be disproportionate, and to avoid the need for assessments in trivial cases’, as stated in RI 164. In such a case, therefore, the entire gain is rolled over by TCGA 1992, s 116(10)(a), and the sum received appears to escape taxation. For most cases, HMRC will accept that ‘small’, for these purposes, means less than 5 per cent of the value or less than £3,000, even if that exceeds 5 per cent of the value of the securities. For a more extensive examination of this matter, see the discussion of TCGA 1992, s 133(4) in Chapter 7.

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9.31 Exchanges involving qualifying corporate bonds TCGA 1992, s 116(15) – losses on QCBs 9.31 ‘(15) In any case where – (a) the new asset mentioned in subsections (10) and (11) above is a qualifying corporate bond in respect of which an allowable loss is treated as accruing under section 254(2); and (b) the loss is treated as accruing at a time falling after the relevant transaction but before any actual disposal of the new asset subsequent to the relevant transaction; then for the purposes of subsections (10) and (11) above a subsequent disposal of the new asset shall be treated as occurring at (and only at) the time the loss is treated as accruing.’ Analysis 9.32 TCGA 1992, s 254(2) was repealed by FA 1998, in respect of loans made on or after 17 March 1998. It dealt with losses deemed to accrue on QCBs in circumstances where the loan represented by the QCB had become irrecoverable. So the circumstance referred to in TCGA 1992, s 116(15) is where there is a gain held over under TCGA 1992, s 116(10)(a) and the QCB subsequently became worthless so that a loss accrued under TCGA 1992, s 254(2). Where this happens, the QCB is deemed to have been disposed of, whether under TCGA 1992, s 116(10) or (11), at the same time that the loss accrued. This then permits the allowable capital loss arising under TCGA 1992, s 254(2) to be set off against the rolled-over gain under TCGA 1992, s 116(10)(a). On the basis of the repeal of TCGA 1992, s 254, TCGA 1992, s 116(15) can only apply to QCBs issued before 17 March 1998. TCGA 1992, s 116(16) – priority over loan relationships rules 9.33 ‘(16) This section has effect for the purposes of corporation tax notwithstanding anything in section 464(1) CTA 2009 (matters to be brought into account in the case of loan relationships only under Part 5 of that Act).’ Analysis 9.34 This is a declaration that nothing in the loan relationships legislation can override the operation of TCGA 1992, s 116. 250

Exchanges involving qualifying corporate bonds 9.35 Whilst CTA 2009, s 464 sets out a list of provisions that are specifically excluded from the general priority of the loan relationship provisions for the purposes of the Corporation Tax Acts, this list is not exhaustive and, in particular, does not include TCGA 1992, s 116(16). This is a good example of separate parts of the Taxes Acts not interacting seamlessly and serves as a reminder that a thorough analysis of the relevant statutes and their interaction is always necessary.

EXAMPLES 9.35 Example 9.1 Mr MacMillan subscribed at par for 10,000 £1 ordinary shares in Commons Ltd in 2012. In 2019, Wilson Plc agreed to acquire his shares for £40 per share. The consideration was to be paid in loan notes of Wilson Plc, redeemable in five annual instalments starting on 30 June 2020. The loan notes are QCBs of Wilson Plc. Analysis: Let us assume that TCGA 1992, s 135 would have operated so that the transaction would have been a reorganisation. The conditions of TCGA 1992, s 116(1) are therefore satisfied. Thus the shares of Commons Ltd are ‘the old asset’ and the QCBs are ‘the new asset’, per TCGA 1992, s 116(4). TCGA 1992, s 116(5) then ensures that the reorganisation provisions do not apply and the QCBs are treated as acquired for all purposes at face value (which is assumed to be market value) on the date of the transaction (TCGA 1992, s 116(6)). The amount is £400,000. We then look to TCGA 1992, s 116(10)(a), which tells us to compute the gain that would have accrued on the disposal, which is £390,000. TCGA 1992, s 116(10)(b) then brings that gain into charge whenever the QCBs are disposed of. Thus, when each tranche of a fifth of the QCBs is redeemed (in June 2020 and annually thereafter) £78,000 of the capital gain is brought into charge on Mr MacMillan.

Example 9.2 Mrs MacMillan had also subscribed at par for 10,000 £1 ordinary shares in Commons Ltd in 2012. Wilson Plc agreed to acquire her shares for £40 per share, too, but payment was to be half in cash and half in the form of QCBs, redeemable in five annual instalments starting on 30 June 2020.

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9.35 Exchanges involving qualifying corporate bonds Analysis: TCGA 1992, s 116(5) again ensures that the reorganisation provisions do not apply and the QCBs are treated as acquired for all purposes at face value, £400,000, (which is assumed to be market value) on the date of the transaction (TCGA 1992, s 116(6)). However, in this case, TCGA 1992, s 116(7) excludes the cash element from the consideration deemed to have been given for the QCBs, and TCGA 1992, s 116(12) tells us that half the gain is to come into charge immediately, so Mrs MacMillan will pay tax in respect of a gain of £195,000. TCGA 1992, s 116(10)(a) still tells us to compute the whole gain that would have accrued on the disposal, which is £390,000. But TCGA 1992, s 116(14) reduces the amounts brought into charge under TCGA 1992, s 116(10)(b) by the amount of the gain as was charged under TCGA 1992, s 116(12), in this case, £195,000. So, for Mrs MacMillan, when the first and second tranche of her QCBs are redeemed, in June 2020 and 2021, representing £78,000 of capital gain on each redemption, the gains are extinguished by the operation of TCGA 1992, s 116(14). When the third tranche is redeemed, the remaining £39,000 of the gain already charged will reduce the gain at June 2022 to £39,000. The remaining gains of £78,000 each will be chargeable in full on redemption of the tranches in June 2023 and 2024.

Example 9.3 In August 2021, Lords Plc bought out Wilson Plc. As part of the transaction, Lords offered the Wilson loan note holders a choice. They could either sell their loan notes to Lords for £1.20 per £1 face value or they could receive 1 Lords ordinary share per £5 face value of QCBs held. Mrs MacMillan decides to take the cash but Mr MacMillan takes the Lords shares. Since the MacMillans have already received some cash and redeemed two tranches of loan notes, Mrs MacMillan will receive a total of £144,000 and Mr MacMillan will still have £240,000 loan notes and will therefore receive 48,000 shares in Lords. Analysis: So far as Mrs MacMillan is concerned, she is disposing of her loan notes and the remainder of the capital gain comes into charge under TCGA 1992, s 116(10)(b). TCGA 1992, s 116(14) will operate to reduce this by the remaining £39,000 of the gain charged under TCGA 1992, s 116(12) and she will now pay tax on a net gain of £195,000. It appears that the premium element of the sale, ie the extra 20p per loan note, £24,000, is not charged to income tax, as there are no provisions whereby such a premium is chargeable on an individual. If the recipient of such a premium were a company, it would be charged to corporation tax as a profit on a loan relationship. 252

Exchanges involving qualifying corporate bonds 9.37 When Mr MacMillan takes shares in Lords, TCGA 1992, s 116(9) applies, so that he is deemed to have disposed of his loan notes and acquired the Lords shares. Thus the remaining £234,000 of his gain comes into charge. We assume that, since this is an arm’s-length transaction, the consideration is the market value of the Lords Plc shares acquired.

CONCLUSION 9.36 TCGA 1992, s 116 takes a different approach from TCGA 1992, ss 127 and 135, to ensure that there is no loss of tax when the assets acquired on the reorganisation (the new holdings) are outside the scope of corporation tax on chargeable gains, by virtue of being QCBs. As with much of the legislation we are looking at, this is an adaptation of the original relatively straightforward model for reorganisations, introduced in 1965, to take account of later changes in the tax code. In this case, the adaptation is to the regime for the taxation of loan relationships, introduced in 1996 and now found in CTA 2009, Part 5. The application of the loan relationship provisions in the context of company reorganisations is covered in Chapter 1.

STAMP TAXES 9.37 If shares in X are transferred to Y in return for the issue of QCBs by Y, a stamp duty charge will arise, payable by Y and based on the ‘value’ of the QCBs issued. If the QCB is a marketable security, ‘value’ means market value. If the QCB is not marketable, ‘value’ means face value. The statutory definition of marketable is ‘of such a description as to be capable of being sold in any stock market in the UK’ (Stamp Act 1891, s 122(1)). It is considered that this automatically excludes securities issued by a UK private limited company. The only relief which may be available is group relief, if Y and the original shareholder of X are members of a 75 percent worldwide corporate group. The issue of debt instruments in the course of a transaction does not normally in itself give rise to a stamp tax charge. However, the instruments may be subject to stamp duty or SDRT on subsequent transfer. Most normal debt instruments on commercial terms are exempt from stamp taxes but the insertion of terms intended to prevent the debt from being a QCB may prevent the exemption from applying (FA 1986, s 79).

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9.38 Exchanges involving qualifying corporate bonds

VALUE ADDED TAX 9.38 The fact that the Buyer issues QCBs makes no difference to the parties’ VAT treatment on the main sale. The Buyer, instead of or as well as making an immediate issue of shares, also makes an issue of QCBs; but that is not a supply by the Buyer, either on initial completion or when it redeems the QCBs. The Buyer’s input VAT position at all stages will follow the principles explained in Chapter 8. As far as the Sellers are concerned they, of course, sometimes make a (normally) exempt supply of shares at the time of the main sale. They will normally make no supply when the QCBs are redeemed. However, if the QCBs are held as assets of a business, and carry interest, or are redeemed at a premium, that prima facie means that the Sellers are making a supply (of loan credit) to the Buyer for the interest or premium as consideration. Those will be exempt supplies by the Sellers (Value Added Tax Act 1994, Sch 9, Group 5, Item 6), though they are ignored as outputs for the purpose of any ordinary A/(A + B) partial exemption calculation of the Sellers: VAT Regulations 1995, SI 1995/2518, reg 101(3)(e), (8). If the Buyer belongs outside the EU, the interest and any premium will be outside the scope of VAT but with the right of recovery, effectively zero-rated: VAT (Input Tax) (Specified Supplies) Order 1999, SI 1999/3121. Having said that, it will be arguable in some cases, even if the QCBs are on a business balance sheet of the Sellers, that, if the Sellers’ business is not a financial business, the interest is outside the scope of VAT: Fanfield Limited (2011) TC 919. But this is rather an academic point in most cases. This VAT analysis applies equally if the Sellers take loan notes which are not QCBs.

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Chapter 10

Earn-outs

INTRODUCTION 10.1 As we have seen, TCGA 1992, ss 135 and 136 provide a very generous relief for takeovers and reconstructions which satisfy certain criteria. The original shares/debentures and the replacement shares/debentures are treated, for capital gains purposes, as the same asset applying the relief in TCGA 1992, s 127 ‘with the necessary adaptations’. However, this relief is not generous enough to facilitate all types of takeover. In some takeovers, the consideration consists of an upfront cash payment or paper issue, plus the possibility of further cash or paper issues depending upon future events. Usually, the events in question are future profits of the target company. This contingent element of consideration is known in the business world as an ‘earn-out’. The basic rules for taxing this type of transaction derive from the seminal case of Marren v Ingles 54 TC 76. In this case, shares in a private company were sold in 1970 for an immediate payment of £750 per share, plus a further cash sum to be calculated by reference to the share price on the first day following flotation. The flotation took place in 1972. It was common ground that the disposal consideration in 1970 included both the £750 cash and the contingent right to receive further consideration. For these purposes, the contingent right had to be valued at the 1970 disposal date. The House of Lords decided that the contingent right was a type of incorporeal property and was itself an asset for the purposes of capital gains (see TCGA 1992, s 21 for a definition of ‘asset’). Furthermore, it was held that the receipt of the contingent consideration in 1972 was a ‘capital sum derived from’ this asset giving rise to a further disposal in 1972 by virtue of TCGA 1992, s 22. This decision resolved a number of uncertainties, but also gave rise to further problems. Valuing the contingent right is of course an intractable practical problem and this has not diminished in the years since the case was heard. However, the key tax issue arising from the decision only becomes apparent when we forget the facts of Marren v Ingles, which was a cash transaction, and apply the same reasoning to a paper-for-paper deal. In a paper-for-paper 255

10.2 Earn-outs context, Marren v Ingles means that the original sale consists of exchanging shares for newly-issued shares, plus a separate ‘chose in action’ – a contingent right to receive shares which is not in itself a share or a debenture. When the contingent paper consideration is issued, the chose in action is exchanged for shares. In an earn-out, what most taxpayers would like to do is treat the original shares/ debentures and the new shares/debentures (including the variable, contingent element) as the same asset with no disposal taking place. However, there is nothing in TCGA 1992, s 135 which enables them to do this. The chose in action received on the initial disposal is not a share or a debenture and the relief prima facie cannot apply. Until 1996, relief was available for earn-outs on a concessional basis only through the use of Extra-Statutory Concession D27. FA 1997 codified the concession as TCGA 1992, s 138A. TCGA 1992, s 138A is deemed always to have had effect so that it is no longer necessary to consider the effect of the concession on shares or debentures acquired through pre-1996 earn-outs. There are different rules for earn-out rights acquired before 26 April 1988 which will not be dealt with here. This whole area is dealt with very fully in HMRC Capital Gains Manual, paragraphs CG58000 et seq. The manual includes a number of worked examples.

THE LEGISLATION TCGA 1992, s 138A(1) – what is an ‘earn-out’? 10.2 ‘(1) For the purposes of this section an earn-out right is so much of any right conferred on any person (“the seller”) as – (a) constitutes the whole or any part of the consideration for the transfer by him of securities or debentures of a company (“the old securities”); (b) consists in a right to be issued with shares in or debentures of another company (“the company”); (c)

is such that the value or quantity of the shares or debentures to be issued in pursuance of the right (“the new securities”) is unascertainable at the time when the right is conferred; and

(d) is not capable of being discharged in accordance with its terms otherwise than by the issue of the new securities.’ 256

Earn-outs 10.3 Analysis 10.3 This definition contains the definition of an ‘earn-out’, often referred to as ‘deferred consideration’, for the purposes of this legislation. There are a number of points that are worthy of note. First, the earn-out right must be all or part of the consideration for a disposal of shares or debentures of a company. Secondly, the earn-out itself must be payable in the form of shares or debentures issued by the other company. If it is in the form of a mixture of cash and shares or debentures, TCGA 1992, s 138A can apply to the share or debenture element. More important, TCGA 1992, s 138A cannot apply in a case where the recipient has a choice whether to receive the deferred consideration in the form of cash or shares. There must be no choice as to the settlement of the earn-out by the issue of shares or securities, although we believe that a choice can exist over whether to take shares or other securities and in what proportions. The concept of vendor placing is not mentioned in the legislation, but CG58085 helpfully states that TCGA 1992, s 138A can still apply even if the shares or debentures issued to the vendor as consideration for an earn-out are immediately sold by the vendor for cash. All that the legislation requires is that the earn-out be settled by the issue of shares or debentures. Thirdly, the section only applies to situations where the value or quantity of the new paper is ‘unascertainable’ at the time the right is conferred. The term ‘unascertainable’ is defined in TCGA 1992, s 138A(7)–(10) below. If the deferred consideration fails the test of ‘unascertainable’, TCGA 1992, s 48 applies. This section makes the whole consideration, including the deferred element, immediately taxable, with an appropriate adjustment to the gain calculation if any of the deferred amount does not materialise or becomes irrecoverable. However, if the contingent consideration is ascertainable but is in the form of shares or securities, CG58020 reminds us that, if the ordinary conditions of TCGA 1992, s 135 (or, as the case may be, TCGA 1992, s 116) are satisfied, TCGA 1992, s 135 or 116 will apply to the contingent consideration. That is, if the deferred element is itself a share or debenture in the purchaser, the normal reorganisation rules will apply. TCGA 1992, s 138A applies equally to all ‘persons’, including both individuals and companies. So it can apply to a company agreeing to a contingent further consideration. This has led to some difficulties in the context of the substantial shareholding exemption. If a trading group sells a trading company, the substantial shareholding exemption would prima facie be available for both the initial consideration and the value of the earn-out right, but the consideration received when the earn-out matures or comes to fruition would not be exempt, 257

10.4 Earn-outs as the company would be disposing of a chose in action or a deemed security under TCGA 1992, s 138A(3)(a), not shares or an asset related to shares. And the substantial shareholding exemption does not apply to the disposal of a chose in action. So disposal strategies have been developed to ensure that the substantial shareholding exemption remains available for the whole of the consideration. TCGA 1992, s 138A(2) – the avoidance condition 10.4 ‘(2) Where – (a) there is an earn-out right; and (b) the exchange of the old securities for the earn-out right is an exchange to which section 135 would apply, in a manner unaffected by section 137, if the earn-out right were an ascertainable amount of shares in or debentures of the new company;

this Act shall have effect, in the case of the seller and every other person who from time to time has the earn-out right, in accordance with the assumptions specified in subsection (3) below.’

Analysis 10.5 This subsection tells us that the result of an earn-out falling within TCGA 1992, s 138A is given at TCGA 1992, s 138A(3). However, before we get there, we have to satisfy the tests in TCGA 1992, s 137(1): is the transaction being carried out for bona fide commercial reasons and not for the avoidance of tax on gains (see Chapter 13)? Remember also that TCGA 1992, s 138 provides a facility for obtaining pre-transaction clearance (see Chapter 14). TCGA 1992, s 138A(2A) – election out of s 138A 10.6 ‘(2A) Subsection (2) above does not have effect if the seller elects under this section for the earn-out right not to be treated as a security of the new company.’ Analysis 10.7 For earn-out rights conferred after 9 April 2003, TCGA 1992, s 138A(2A) gives the taxpayer the right to disapply TCGA 1992, s 138A(2) by election and to be taxed under normal principles instead. This might happen 258

Earn-outs 10.9 if, for example, a vendor’s shareholding in the original company qualified for full business asset disposal relief (formerly known as ‘entrepreneurs’ relief’). He or she might then choose to take the tax cost at the reduced rate of capital gains tax immediately, in case the shares or securities issued by the purchaser do not qualify as business assets. TCGA 1992, s 138A(3) – the consequences of earn-out treatment 10.8 ‘(3) Those assumptions are – (a) that the earn-out right is a security within the definition in section 132; (b) that the security consisting in the earn-out right is a security of the new company and is incapable of being a qualifying corporate bond for the purposes of this Act; (c)

that references in this Act (including those in this section) to a debenture include references to a right that is assumed to be a security in accordance with paragraph (a) above; and

(d) that the issue of shares or debentures in pursuance of such a right constitutes the conversion of the right, in so far as it is discharged by the issue, into the shares or debentures that are issued.’ Analysis 10.9

Essentially, we are asked to pretend that:

●●

the earn-out right is itself a non-QCB security issued by the transferor company in a paper-for-paper transaction to which TCGA 1992, s 135 applies; and

●●

that the issue of securities on fruition of the right is to be treated as a conversion of securities to which TCGA 1992, s 132 applies.

Therefore, both legs of the earn-out transaction are treated as reorganisations as both TCGA 1992, ss 132 and 135 impose TCGA 1992, ss 127–131 with any ‘necessary adaptations’. The creation of the earn-out right is treated as a share-for-non-QCB exchange, and is dealt with as a normal exchange under TCGA 1992, s 135 (Chapter 8). The treatment of the deemed conversion on fruition of the earn-out is based on the status of the security issued. If it is a non-QCB, then there is no tax effect, being just a conversion under TCGA 1992, s 132 (Chapter 8). If it is a QCB, TCGA 1992, s 116 would apply through the operation of TCGA 1992, s 132, conversion of a non-QCB to a QCB (Chapter 9). 259

10.10 Earn-outs TCGA 1992, s 138A is silent about the treatment of deferred consideration that does not satisfy the conditions of TCGA 1992, s 138A(1) or (2) or where there is an election under TCGA 1992, s 138A(2A). The answer, of course, is that normal principles are applied. If (or to the extent that) the deferred consideration is not in the form of shares or debentures, or if the TCGA 1992, s 138A(2A) election is made or the conditions of TCGA 1992, s 137(1) are not met, then the Marren v Ingles principle must be applied. The value of the earn-out right will have to be ascertained and charged as part of the initial gain, then any further consideration will be a disposal of the chose in action. Sometimes, the company which is committed to issuing the earn-out securities is itself taken over by a second purchaser and the second purchaser may offer an earn-out consideration in return for the extinguishment of the original earn-out. This secondary earn-out is equally capable of falling within TCGA 1992, s 138A. The analysis is that TCGA 1992, s 138A(3) treats the first earn-out as if it were a security for all purposes of the Act. Therefore, if the second earn-out meets the conditions of TCGA 1992, s 138A(1) and (2), then it too can be treated as a security for all purposes of the Act. Thus, we have a paper-for-paper exchange to which TCGA 1992, s 135 can apply. CG58088 helpfully points out that the legislation is capable of repeated application in a sequence of takeovers. TCGA 1992, s 138A(4) – replacement of earn-out right 10.10 ‘(4) For the purposes of this section where – (a) any right which is assumed, in accordance with this section, to be a security of a company (“the old right”) is extinguished; (b) the whole of the consideration for the extinguishment of the old right consists in another right (“the new right”) to be issued with shares in or debentures of that company; (c)

the new right is such that the value or quantity of the shares or debentures to be issued in pursuance of the right (“the replacement securities”) is unascertainable at the time when the old right is extinguished; and

(d) the new right is not capable of being discharged in accordance with its terms otherwise than by the issue of the replacement securities;

the assumptions specified in subsection (3) above shall have effect in relation to the new right, in the case of the person on whom the new right is conferred and every other person who from time to time has the new right, as they had effect in relation to the old right.’ 260

Earn-outs 10.14 Analysis 10.11 This provision applies where an earn-out right is varied before maturity. Essentially, so long as the replacement earn-out right also satisfies the conditions that are repeated in TCGA 1992, s 138A(4), the new right is also treated as a security to which TCGA 1992, s 138A(3) applies. We assume that the consequences of the new earn-out right failing these conditions will again depend on the condition(s) failed. If (or to the extent that) the new earn-out right is not in the form of shares or debentures, or an election is made under TCGA 1992, s 138A(4A) (see below) or the conditions of TCGA 1992, s 137(1) are not met, then the Marren v Ingles principle must be applied. The value of the initial earn-out at the time of the variation will have to be ascertained and charged as a gain on disposal of that earn-out right, then any further consideration will be a disposal of the chose in action. If the new earn-out right fails the test of ‘unascertainable’, TCGA 1992, s 48 applies, as described above. TCGA 1992, s 138A(4A) – election out of s 138A 10.12 ‘(4A) Subsection (4) above does not have effect if the person on whom the new right is conferred elects under this section for it not to be treated as a security of the new company.’ Analysis 10.13 For earn-out rights conferred after 9 April 2003, TCGA 1992, s 138A(4A) gives the taxpayer the right to disapply TCGA 1992, s 138A(4) by election and to be taxed under normal principles instead. The consequences are discussed under TCGA 1992, s 138A(4) above. TCGA 1992, s 138A(5) and (6) – election out of s 138A 10.14 ‘(5) An election under this section in respect of any right must be made, by a notice given to an officer of the Board – (a) in the case of an election by a company within the charge to corporation tax, within the period of two years from the end of the accounting period in which the right is conferred; and

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10.15 Earn-outs (b) in any other case, on or before the first anniversary of the 31st January next following the year of assessment in which that right is conferred. (6) An election under this section shall be irrevocable.’ Analysis 10.15 For earn-out rights granted before 10 April 2003, TCGA 1992, s 138A did not apply unless the taxpayer made an election. This position was reversed for earn-out rights conferred after 9 April 2003 and TCGA 1992, s 138A now applies unless the taxpayer elects that it shall not apply either under TCGA 1992, s 138A(2A) or (4A). The election must be in writing to ‘an officer of the Board’, presumably the normal case officer who deals with the taxpayer’s affairs. The time limit for an election by a company is two years from the end of the accounting period in which the right is given. For an individual, the time limit for the election is roughly 22 months from the end of the year of assessment in which the right is given, ie the second 31 January following the 5 April of the year of assessment in which the right is given. The election is irrevocable once made, which makes the election a one-way bet. That is, once a taxpayer has elected not to treat an earn-out as a nonQCB, the chose in action is treated as a normal chargeable asset. If the initial earn-out is not treated as a security, a replacement of that right by another right, such as under TCGA 1992, s 138A(4), above, cannot be used to bring the right back into the regime. This is because the condition in TCGA 1992, s 138A(4)(a), that there should be a right treated as a security by TCGA 1992, s 138A(3), is failed, so TCGA 1992, s 138A(4) is not capable of applying to the amended earn-out right and the taxpayer cannot treat the secondary earn-out right as a security. A further technical point relating to elections is helpfully highlighted in CG58086. Only the vendor of old shares/debentures can decide whether to make an election. If he sells or gives the right to another person (including a spouse), that other person cannot make the election. This is because the legislation says that the election can only be made by the seller (TCGA 1992, s 138A(2A)) or the person on whom the right or new right is conferred (TCGA 1992, s 138A(4A)). There is nothing in the legislation, however, that says that that person must still own the earn-out right when making the election!

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Earn-outs 10.16 TCGA 1992, s 138A(7) to (11) – meaning of ‘unascertainable’ 10.16 ‘(7) Subject to subsections (8) to (10) below, where any right to be issued with shares in or debentures of a company is conferred on any person, the value or quantity of the shares or debentures to be issued in pursuance of that right shall be taken for the purposes of this section to be unascertainable at a particular time if, and only if – (a) it is made referable to matters relating to any business or assets of one or more relevant companies; and (b) those matters are uncertain at that time on account of future business or future assets being included in the business or assets to which they relate. (8) Where a right to be issued with shares or debentures is conferred wholly or partly in consideration for the transfer of other shares or debentures or the extinguishment of any right, the value and quantity of the shares or debentures to be issued shall not be taken for the purposes of this section to be unascertainable in any case where, if – (a) the transfer or extinguishment were a disposal; and (b) a gain on that disposal fell to be computed in accordance with this Act;

the shares or debentures to be issued would, in pursuance of section 48, be themselves regarded as, or as included in, the consideration for the disposal.

(9) Where any right to be issued with shares in or debentures of a company comprises an option to choose between shares in that company and debentures of that company, the existence of that option shall not, by itself, be taken for the purposes of this section either – (a) to make unascertainable the value or quantity of the shares or debentures to be issued; or (b) to prevent the requirements of subsection (1)(b) and (d) or (4)(b) and (d) above from being satisfied in relation to that right. (10) For the purposes of this section the value or quantity of shares or debentures shall not be taken to be unascertainable by reason only that it has not been fixed if it will be fixed by reference to the other and the other is ascertainable. (11) In subsection (7) above “relevant company”, in relation to any right to be issued with shares in or debentures of a company, means – (a) that company or any company which is in the same group of companies as that company; or 263

10.17 Earn-outs (b) the company for whose shares or debentures that right was or was part of the consideration, or any company in the same group of companies as that company;

and in this subsection the reference to a group of companies shall be construed in accordance with section 170(2) to (14).’

Analysis 10.17 TCGA 1992, s 138A(7) defines the term ‘unascertainable’ quite restrictively as meaning referable to any business or assets of a relevant company and being unascertainable due to future events being included. So a contingent right to further consideration based on future profits would probably qualify, but a right to receive one additional share for every point by which the FTSE 100 index exceeds 6,000 on a future date would not as it does not refer to the business or assets of the relevant company. Of course, this consideration might be unascertainable in real terms, but it is not unascertainable within TCGA 1992, s 138A(7), so in this case the Marren v Ingles principle would apply. For these purposes, ‘relevant company’ is defined in TCGA 1992, s 138A(11) as the target company, the company issuing the shares or debentures and any company in either the target’s or the issuer’s TCGA 1992, s 170 group. TCGA 1992, s 138A(8) appears a little obscure, as is CG58027 which discusses it, but the main thrust appears to be to ensure that consideration that is chargeable under TCGA 1992, s 48 as ascertainable deferred consideration cannot also be unascertainable within the meaning of TCGA 1992, s 138A(7). TCGA 1992, s 138A(9) tells us that deferred consideration is not ‘unascertainable’ merely because the recipient has the ability to choose between receiving shares and receiving debentures. However, we are also told that the existence of that choice is otherwise still within the terms of TCGA 1992, s 138A, so that an ability to choose between shares or debentures will still count as satisfying the conditions of TCGA 1992, s 138A(1)(b), (d) or TCGA 1992, s 138A(4)(b), (d). TCGA 1992, s 138A(10) tells us that the deferred consideration is not unascertainable merely because the ‘quantity’ of shares or debentures is to be fixed by reference to the ‘value’ or vice versa. CG58026 supplies helpful examples of this restriction. If an agreement specifies that the deferred consideration consists of an issue of shares to the value of £100,000, this is not regarded as ‘unascertainable’, although the number of shares is unknown. The policy here is that, of course, the value is known, so the consideration cannot be said to be unascertainable in any real sense.

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Earn-outs 10.18 In the second example, the deferred consideration is given as £10,000 shares (we assume that 10,000 £1 shares is meant here). Again, TCGA 1992, s 138A(1) tells us that this is not unascertainable, even though the value of the shares to be issued is not known. In this case, the policy is less clear. The value of the shares to be issued is both unknown and unascertainable in a real world sense, even if the number is known. Furthermore, in many cases, the value of those shares will be referable to matters relating to the business or assets of the issuing company (to paraphrase TCGA 1992, s 138A(7)). Conversely, one might argue that the value of debentures to be issued on such terms would be known, at least within reasonably close limits. In any event, in genuine commercial cases, it is straightforward to avoid falling into TCGA 1992, s 138A(10).

EXAMPLES 10.18 These examples are intended to demonstrate the operation of TCGA 1992, s 138A in a number of circumstances. Example 10.1 George owns shares in Leopard Ltd. Black Cat Ltd makes an offer to buy Leopard in an all paper deal, whereby George will receive Black Cat shares now and plus a contingent right to receive more shares in Black Cat based on the results of the Leopard business over the next five years. Analysis: Let us assume that we are within the reorganisation rules. TCGA 1992, s 135 will apply to treat the share-for-share exchange element as an ordinary reorganisation. TCGA 1992, s 138A(3) tells us to assume that the earn-out right is to be treated as a non-QCB (TCGA 1992, s 138A(3)(b)), so we have a TCGA 1992, s 135 transaction which exchanges shares for a deemed non-QCB, which is squarely within the terms of TCGA 1992, s 135. So the entire transaction is treated as a reorganisation. When the earn-out right comes to fruition, TCGA 1992, s 138A(3) also tells us that the issue of Black Cat shares is treated as a conversion of securities within TCGA 1992, s 132. In this case, it is a conversion of the deemed non-QCB to a share, which is also treated as a reorganisation. Overall, therefore, George has exchanged all his Leopard shares for Black Cat shares. If he had sold either the earn-out or the Black Cat shares during the earn-out period, it would have been necessary to apportion the allowable base cost according to the formula given in TCGA 1992, s 129. 265

10.18 Earn-outs Example 10.2 Pete owns shares in Cougar Ltd, which is also acquired by Black Cat in a paper-for-paper transaction. In this case, Cougar was considered worthless, so Black Cat offered an all-contingent deal, with Black Cat non-QCB debentures to be issued to Pete depending on the results of the Cougar business over five years. Analysis: Again, assuming TCGA 1992, s 135 would otherwise apply, we look to TCGA 1992, s 138A(3). This tells us to assume that the first leg of the transaction is a paper-for-paper exchange of a share for a non-QCB security. So, again, there is no chargeable gain at this point. TCGA 1992, s 138A(3)(d) tells us that the issue of the non-QCB debentures is treated as a conversion of securities within TCGA 1992, s 132. The conversion of a deemed non-QCB into an actual non-QCB is a conversion on first principles (ie it does not have to be within the non-exhaustive list at TCGA 1992, s 132(3)), and has no chargeable tax consequences as it is treated as a reorganisation. The overall result of the transaction is that Pete has effectively done a sharefor-debenture exchange, followed by a non-QCB to non-QCB conversion. The final Black Cat QCBs are treated as having been acquired at the same time and for the same price as the original shareholding in Leopard.

Example 10.3 Keith owns some non-QCB debentures in Panther Ltd. Black Cat offers to acquire Panther and extends the offer to include a paper-for-paper transaction for the debenture holders. In this case, Black Cat offers a £1-for-£1 exchange of debentures with a contingent element based on future results, as a sweetener. All the Black Cat debentures in this case will be QCBs. Analysis: The first transaction is prima facie a reorganisation within TCGA 1992, s 135, ie a debenture-for-debenture exchange. However, the new holding consists partly of QCBs, and partly of the earn-out right, which is deemed to be a non-QCB by TCGA 1992, s 138A(3)(b). The non-QCB-for-QCB element must be dealt with under TCGA 1992, s 116, while the non-QCB-for-deemed non-QCB element is a reorganisation within TCGA 1992, s 135. The question is how to apportion the original base cost of the Panther debentures between the elements of the new holding, in computing the gain 266

Earn-outs 10.19 to be computed and held over under TCGA 1992, s 116(10)(a)? This is not a case to which the special rules of TCGA 1992, s 129 or 130 can apply, as they only apply on the part-disposal of a new holding. So the normal rule in TCGA 1992, s 42 should apply, and the apportionment be made on the basis of the A/(A+B) formula. But this is hard to apply as there is no actual cash consideration. We then look to TCGA 1992, s 52(4), which requires a ‘just and reasonable’ apportionment of consideration and expenditure in mixed transactions. But, again, we have no set values on which to base such an apportionment. In theory, therefore, it may be necessary to value the QCBs and the earn-out right in order to come up with a reasonable answer. In practice, if Keith retains the Black Cat QCBs, there is no practical requirement to actually compute the gain (albeit TCGA 1992, s 116(10)(a) requires the computation to be carried out). The fruition of the earn-out is brought within TCGA 1992, s 132 by TCGA 1992, s 138A(3)(d) and, since this is a conversion of a deemed non-QCB into a QCB, TCGA 1992, s 132(3)(a)(ia) applies. This then takes us into TCGA 1992, s 116(10), as the new asset is the QCB. So the appropriate chargeable gain should be computed as if the earn-out right had been disposed of at market value (TCGA 1992, s 116(10)(a)) and the gain crystallises when the QCB is disposed of by sale, redemption or any other route (TCGA 1992, s 116(10)(b)). This brings us back to the difficulties noted above and the practical solution proposed. If, in fact, Keith holds onto all the QCBs throughout the earn-out period, the entire transaction can be treated as a single non-QCB-for-QCB exchange, with an overall gain computed under TCGA 1992, s 116(10)(a) and a single charge when the gain crystallises on disposal, under TCGA 1992, s 116(10)(b). There are various examples in CG58070 et seq.

Interaction of earn-out rules with ITEPA 2003, Part 7 10.19 In many earn-outs, the vendors are both shareholders in the target company and directors or employees who continue to work for the target company (and sometimes the acquirer) after the takeover. The question arises whether the shares/debentures issued to them under the earn-out are in consideration of the original sale of shares or in consideration of work done after the takeover. The drafting of Income Tax (Earnings and Pensions) Act 2003 (‘ITEPA 2003’), s 421B(1)–(3) appears to put the answer beyond doubt. It brings the 267

10.20 Earn-outs shares/debentures within the scope of the ‘employment-related securities’ legislation which, for many individuals, is likely to result in higher effective charges than capital gains tax. This caused considerable protest when ITEPA 2003 was introduced and, as a result, the practical impact of ITEPA 2003 has been softened by statements on the HMRC website. However, a full consideration of this area is beyond the scope of this book.

CONCLUSION 10.20 The earn-out rules provide an example of how a relief designed for one purpose – the tax-free reorganisation of corporate groups – has been adapted to deal with a specific commercial circumstance – the disposal of companies on a deferred consideration basis linked to future performance. This in turn led to a cottage industry developing amongst tax professionals, the aim of which was to ensure that earn-out rights were documented in a way that achieved the desired tax result – namely, the deferral of a tax charge until the ultimate cash realisation of a finally ascertained price. As legislation changes, however, the challenges to professionals change as well. For example, provisions of ITEPA 2003 created a new set of problems which went beyond the scope of the reorganisation rules. It has now become necessary to ask whether deferred consideration rights are not consideration for a disposal of shares, but rather constitute reward for the services in a subsequent employment of an individual in the company concerned. The repeal of business asset taper relief and its replacement by the much more limited business asset disposal relief (formerly known as ‘entrepreneurs’ relief’), together with the reduction in the capital gains tax rate for individuals to 10%, means that TCGA 1992, s 138A may well decrease in importance, as it will be less important to structure the earn-out right to qualify as a nonQCB. Indeed, quite the opposite; since an non-QCB holding, by itself, does not qualify for business asset disposal relief, these forms of earn-out are less popular in cases where the vendor does not also retain a 5% holding in the company following the disposal.

STAMP TAXES 10.21 In the case of an earn-out, it is likely that the questions of whether the consideration is contingent and/or ascertainable will be important in determining the stamp duty cost of any share transfers. These matters are also discussed in Chapter 2. Two related principles affect the measurement of consideration for stamp duty purposes in relation to an earn-out. If the transaction is exempt or qualifies for 268

Earn-outs 10.21 stamp duty relief as described in previous chapters, all well and good. However if stamp duty is going to be paid, the precise drafting of the terms of the earnout is critically important. Unfortunate drafting can lead to unreasonable charges; sadly, commercial needs are often opposed to good stamp tax drafting and it is not unusual for unreasonable charges to arise. First, stamp duty is only chargeable on consideration which is ‘ascertainable’ at the date of the Transfer. This principle is not overtly stated in the legislation, but it is HMRC’s long established interpretation of words now in FA 1999, Sch 13, para 2. Consideration is ascertainable if it is possible to deduce one or more specific figures for it from documents or facts extant at the time of execution of the Transfer. It does not matter whether payment of that particular amount is certain or contingent on future events. Note that the test is whether the amount is capable of being ascertained at the relevant date, not whether it has been ascertained. Example 10.4 – unascertainable consideration On 1 January 2012, Conglomerate plc agrees to buy all of the shares in Dan Ltd from Daniel for consideration equal to twice the pre-tax profits of Dan Ltd for the year to 28 February 2012 (with no upper or lower limit). The share transfer is executed on 1 February 2012. The consideration is entirely unascertainable at the date of the Transfer, because it is based on events which will happen after that date, so there is no consideration on which stamp duty may be charged. There is no requirement to submit the Transfer to HMRC for stamping, even once the actual consideration is determined. However if the share transfer is executed on 1 March 2012, the year on the profits of which the consideration will be based has now ended. The profits are not yet likely to have been ascertained, but they are nonetheless ascertainable, because all events impacting on the profit figure have happened. Stamp duty will therefore be chargeable on the actual consideration. Since it is unlikely this will be known when the deadline for payment of stamp duty arrives, Conglomerate plc may wish to apply for provisional stamping, with adjustment to actual figures once they are known, as explained in 2.6. Example 10.5 – an ascertainable sum The facts are as in Example 10.4, except that the consideration is specified to be £1 million, plus (or minus) twice the amount by which the February 2012 profits exceed (or fall short of) £500,000. Stamp duty will be charged on the £1 million, because that is an ascertainable sum, with no subsequent adjustment once actual consideration is finalised.

269

10.22 Earn-outs The LM Tenancies case ([1996] STC 880) involved an attempt to render consideration unascertainable but limit the risk of change, by linking it to the value, a few days later, of a security with a very stable price. It was held that the consideration was not truly unascertainable and should be taken as the figure based on the value of the security at the date of the Transfer. The second complication is the so-called ‘contingency principle’. This is based on old case law, especially the Underground Electric Railways cases ([1905] 1 KB 174, [1914] 3 KB 210). The principle states that any sum stated to be payable by way of consideration on the happening of some contingency is subject to stamp duty as if certainly payable. Combining this with the question of whether consideration is ascertainable, HMRC consider that, if more than one figure can be deduced, the consideration must be assumed to be the highest of these. Example 10.6 – two or more ascertainable sums The facts are as in Example 10.4, but the consideration is subject to a minimum of £500,000 and a maximum of £2 million. £500,000 and £2 million are both ascertainable sums, and the contingency principle requires the assumption that the higher amount of £2 million will be paid. Stamp duty is therefore chargeable on this sum, with no adjustment or refund if the actual consideration eventually proves to be less. Thus it can be seen that specifying a cap on the consideration payable on an earn-out will ensure that stamp duty is payable on that maximum amount irrespective of the consideration finally paid.

VALUE ADDED TAX 10.22 The fact that there is an earn-out makes no difference to the parties’ VAT treatment on the main sale. The Buyer, instead of simply making an immediate issue of shares or securities, also issues earn-out rights, but that is not a supply by the Buyer, either on initial completion or when the earn-out crystallises and the Buyer issues the resulting shares or securities, or when it finally redeems the securities. The Buyer’s input VAT position at all stages will follow the principles explained in Chapter 8. As far as the Sellers are concerned, they, of course, make a (normally) exempt supply of shares at the time of the main sale, but in the writers’ view make no supply when the earn-out crystallises into shares or securities or when resulting securities are redeemed. In the unusual case where the Sellers incur professional fees or other costs in relation to these later events, and if the Sellers are still carrying on a business of which the earn-out rights are assets, the Sellers should claim that the input VAT on the cost is general overhead input VAT of their continuing business, following Customs & Excise Commissioners v Midland Bank Plc [2000] STC 501, ECJ. 270

Chapter 11

Interaction with substantial shareholding exemption

INTRODUCTION 11.1 Following the introduction of the substantial shareholding exemption in 2002,1 we also have to look at how those provisions interact with the much older reorganisation provisions or, rather, to transactions that are deemed to be treated as reorganisations either by TCGA 1992, s 135 or 136. Back in 2002, the Inland Revenue (as it was then) published on its website a note entitled ‘The Substantial Shareholding Exemption Regime and Share Reorganisations’. This note is largely reproduced at CG63170a. This chapter borrows substantially from that original note. There are four types of transaction to look at: internal reorganisations (whether by share-for-share exchange or by reconstruction within TCGA 1992, s 136), disposals (again within TCGA 1992, s 135 or 136) and internal or external transactions involving QCBs.

1 At TCGA 1992, Sch 7AC.

SHARE-FOR-SHARE EXCHANGES – INTERNAL REORGANISATIONS 11.2 Probably the easiest way to discuss the interaction of the two regimes is to do so by the use of a series of examples. Let us first of all look at the simplest possible internal reorganisation example (Figure 11.1).

271

11.2 Interaction with substantial shareholding exemption Figure 11.1

In this example, as in all the others to follow, we are assuming that all transactions would satisfy the conditions for the substantial shareholding exemption to apply. Here, company H is a holding company of a trading group and each of companies S1 and S2 is either a trading subsidiary or the holding company of a trading sub-group. Also, all transactions are assumed to be carried out for bona fide commercial reasons and not for the avoidance of tax. S1 is sold to S2 and the consideration is an issue of shares by S2 to H. Such a transaction would, absent the substantial shareholding exemption, be a deemed reorganisation for capital gains purposes by virtue of TCGA 1992, s 135. As a result, the base cost of the shares that H holds in S2 will be increased by an amount equal to the original base cost of H’s investment in S1. S2’s investment in S1 will be at market value following the operation of TCGA 1992, s 17 as TCGA 1992, s 171 is disapplied by TCGA 1992, s 171(3). However, we must now look at the impact of TCGA 1992, Sch 7AC. The relevant provision is TCGA 1992, Sch 7AC, para 4, which reads: ‘for the purposes of determining whether an exemption conferred by this Schedule applies, the question whether there is a disposal shall be determined without regard to section 127’. TCGA 1992, Sch 7AC, para 4(5) tells us that the reference to TCGA 1992, s 127 in para 4(1)(b) ‘includes a reference to that provision as applied by any enactment relating to corporation tax’. Therefore, in deciding whether the substantial shareholding exemption applies to the transaction, we have to disregard the deemed application of TCGA 1992, s 127 by TCGA 1992, s 135 and assume that there is, indeed, a disposal. If we look at the transaction without considering the reorganisation provisions, clearly, company S1 has been transferred to another company also within the H group. This would be a transaction to which TCGA 1992, s 171 would apply, ie 272

Interaction with substantial shareholding exemption 11.3 a tax-free, intra-group transfer. However, TCGA 1992, Sch 7AC, para 6(1)(a) tells us that the substantial shareholding exemption does not apply to such ‘no gain no loss’ transfers. Since a TCGA 1992, s 171 transfer falls into this category, TCGA 1992, Sch 7AC cannot apply to the transaction. Once we have determined that, absent the reorganisation provisions, TCGA 1992, Sch 7AC cannot apply, we must ignore the existence of the substantial shareholding exemption and revert to the ‘normal’ reorganisation position, ie the transaction is treated as a reorganisation within TCGA 1992, s 127 by virtue of TCGA 1992, s 135 and the consequences are as referred to above (and in detail in Chapter 8).

An alternative interpretation 11.3 We have seen an interpretation of this transaction which gives a different result. This concentrates on the opening words of TCGA 1992, Sch 7AC, para 4(1) and in particular the phrase ‘the question whether there is a disposal shall be determined without regard to …’ In this view, TCGA 1992, s 127 is only disregarded for the purposes of determining whether there has been a disposal of shares; TCGA 1992, s 127 is not necessarily disregarded in the context of the rest of the Schedule or indeed the rest of TCGA 1992. TCGA 1992, S 127, applied by TCGA 1992, s 135, would deem there to have been no disposal of company S1 by company H. Ignoring TCGA 1992, s 127, therefore, would mean that there is a disposal of S1 by company H and, absent any further considerations, the substantial shareholding exemption is capable of applying to it. Under this interpretation, however, TCGA 1992, s 127 still applies for other purposes, so that a TCGA 1992, s 127 transaction means that TCGA 1992, s 171(3) applies and the disposal is not a ‘no gain no loss’ transfer. As a result, of TCGA 1992, Sch 7AC, para 6(1)(a) is not in point and the substantial shareholding exemption is not disapplied. The overall result is that the internal reorganisation shown in this example is treated as a disposal to which the substantial shareholding exemption applies. Therefore, S2 has a market value base cost in the shares of S1, as this is a transfer between connected parties, and TCGA 1992, s 17(1) applies, so H will have its base cost in S2 enhanced by the market value of S1 (so long as S2 is solvent), not just by the original base cost in S1. The obvious question is which is the correct interpretation? As is often the case, both approaches have their merits. From a practical perspective, however, we would generally accept the HMRC interpretation as being a valid reading of the legislation that gives a result consistent with the apparent policy. 273

11.4 Interaction with substantial shareholding exemption Also, it is an approach that is less likely to generate any technical challenge from HMRC! The other reason for preferring the first view is that, as we shall see, the alternative approach means that the result of a share-for-share exchange is the same whether the transaction is an internal reorganisation or a disposal outside the group. If this had been the intention of the parliamentary draughtsman, it would have been far simpler specifically to provide that the exemption did not apply to any transactions to which TCGA 1992, s 127 applied, rather than to give us the somewhat convoluted provisions at TCGA 1992, Sch 7AC, para 4.

SHARE-FOR-SHARE EXCHANGES – DISPOSALS 11.4

Let us now look at the disposal example (Figure 11.2).

Figure 11.2

In this example, H sells its subsidiary S1 to a third party company, P, in return for an issue of shares by P to H. Again, we must look at the legislation as if the reorganisation provisions do not exist. In this case, we find that we have a disposal of company S1 by company H and this is not a TCGA 1992, s 171 transfer as P is not a member of the H group. Therefore, TCGA 1992, Sch 7AC, para 6 does not disapply the substantial shareholding exemption. So how does the substantial shareholding exemption operate in this scenario? TCGA 1992, Sch 7AC, para 4(3)(a) tells us that, since the substantial shareholding exemption applies, the reorganisation provisions of TCGA 1992, s 127 will not apply. So the transaction this time is treated as a real disposal at market value by H, but the disposal will be exempt under TCGA 1992, Sch 7AC, para 1. The shares issued by P to H will therefore have a base cost

274

Interaction with substantial shareholding exemption 11.6 equivalent to the open market value of subsidiary S1 and P will also have a market value base cost in S1. As noted earlier, this is effectively the same result as we get with the alternative interpretation of the internal reorganisation.

Policy considerations 11.5 Does the result of the disposal transaction make sense from a policy perspective? We believe so. In Figure 11.2, company H has made a real disposal and the increase in value up to the point of the disposal of S1 is intended to be an exempt disposal because it qualifies for the substantial shareholding exemption. Subsequently, a disposal by H of its shareholding in P might not qualify for the substantial shareholding exemption – it may not be a 10% holding or the P group may not be a trading group, for example. If the subsequent disposal by H of its shares in P does not qualify for the substantial shareholding exemption, H would only suffer corporation tax on chargeable gains in respect of the increase in value of the P shares. If the reorganisation provisions applied to the disposal of S1, H’s base cost in the shares issued by P would be the same as the original base cost of the investment in S1. If on the eventual disposal of those shares the substantial shareholding exemption did not apply, H would suffer corporation tax on chargeable gains on the full increase in value of its investment since the shares in S1 were originally acquired, even though a disposal of S1 to P for cash would have been an exempt disposal under the substantial shareholding exemption. Clearly, this would not make any sense from a policy perspective, so it is right that the substantial shareholding exemption, not the reorganisation provisions, should apply to an actual disposal as in Figure 11.2. Conversely, the consequence of the substantial shareholding exemption applying to an internal group reorganisation would be the ability freely to rebase the base costs of holdings in subsidiaries for no other reason than reduce the eventual gain if any of those subsidiaries were disposed of at a time when the exemption did not apply. It is easy to see why HMRC might not have wished this to be possible.

REORGANISATIONS INVOLVING QCBS 11.6 TCGA 1992, Sch 7AC, para 4 also refers to transactions involving QCBs, to which TCGA 1992, s 116 might apply. Again, let us take a simple example (Figure 11.3).

275

11.6 Interaction with substantial shareholding exemption Figure 11.3

In this case, the transaction is similar to Figure 11.1, but, instead of ordinary shares being issued by company S2, a loan note has been issued. Again, following TCGA 1992, Sch 7AC, para 4(1)(a), we must first ignore TCGA 1992, s 116 in deciding whether TCGA 1992, Sch 7AC applies and again we come to the conclusion that, absent the reorganisation provisions, TCGA 1992, s 171 would apply to the transfer of S1 to S2. Therefore, TCGA 1992, Sch 7AC, para 6 stops TCGA 1992, Sch 7AC from applying. Instead, we have a reorganisation transaction to which TCGA 1992, s 116 applies. What does this mean in reality, however? Since the loan note must be a QCB (because all loan relationships of companies are QCBs: TCGA 1992, s 117(A1)), TCGA 1992, s 116(10)(a) tells us to compute the chargeable gain that would have arisen on the disposal by H of S1 and to hold that gain over until such a time as the QCB is disposed of by company H (for example, by sale or by redemption). At that time, TCGA 1992, s 116(10)(b) tells us that the held-over gain comes back into charge. Let us look at the held-over gain computed under TCGA 1992, s 116(10)(a). In our view, we are required to compute the gain that would arise on a hypothetical arm’s-length disposal to a third party (because TCGA 1992, s 116(10)(a) would be meaningless if we were to compute the gain on the basis of a market value disposal to a member of the same group). If company S1 had really been sold to a third party, the substantial shareholding exemption would have applied and there would have been no gain to hold over. As a result, when the loan note is disposed of, there would be no gain to bring into charge under TCGA 1992, s 116(10)(b). So the overall result is that an intra-group transaction where the consideration given in the form of a QCB gives a nil gain, albeit that gain (or non-gain) is held over until the loan note is redeemed!

276

Interaction with substantial shareholding exemption 11.8

Disposals involving QCBs 11.7 What about a disposal outside the group in return for a QCB (Figure 11.4)? Figure 11.4

In this case, H disposes of S1 to a third party, P, in return for a QCB issued by P to H. Following the same reasoning as in Figure 11.2, we determine that the substantial shareholding exemptions should apply as this is not an intra-group transaction to which TCGA 1992, s 171 would apply. Since the substantial shareholding exemption applies, TCGA 1992, Sch 7AC, para 4(3)(a) specifically tells us that TCGA 1992, s 116 does not apply to the transaction and what we have is an exempt gain when H has disposed of its subsidiary S1. Again, therefore, the result of the transaction is that there is no gain. H will have market value base cost in the QCB and P has market value base cost in S1. Therefore, when these transactions are carried out in return for QCB consideration, the result is the same regardless of whether there is an intra-group reorganisation or a disposal.

SIMPLE REORGANISATIONS 11.8 The transaction we have not yet looked at is the simple reorganisation of share capital to which TCGA 1992, s 127 applies directly (Figure 11.5). Figure 11.5

277

11.9 Interaction with substantial shareholding exemption In this example, H holds 100 per cent of the ordinary share capital of the two subsidiaries, S1 and S2. S2 reorganises its share capital so that its shares are now A shares, not ordinary shares. Under TCGA 1992, s 127, H would be deemed not to have disposed of its shareholding in S2 and the A shares will be treated as having been acquired at the same price and at the same time as H’s original investment in ordinary shares of S2. What happens, however, if we ignore TCGA 1992, s 127, as required by TCGA 1992, Sch 7AC, para 4(1)(b), in order to see if there has been a disposal? This is quite an interesting question. It is not clear whether a reorganisation of share capital in this way necessarily involves a disposal. As a matter of company law, it is possible for a company to change the rights associated with its shares, or some of them, without cancelling the original shares and issuing new shares. If this were to be the case, then the reorganisation of S2’s share capital would not appear to involve an actual disposal. Clearly, with no actual disposal, the substantial shareholding exemption cannot apply. Since there is no disposal, the original base cost of the shares should be maintained for capital gains purposes. Alternatively, suppose the ordinary shares of S2 are cancelled and the A shares are immediately issued in their place. This is more likely to be a disposal (as we are ignoring TCGA 1992, s 127), as the original shares are actually cancelled and entirely new instruments are issued. Moreover, it is not a disposal to which TCGA 1992, s 171 applies; TCGA 1992, s 171(1)(a) refers to a situation where ‘a company … disposes of an asset to another company … when both companies are members of the same group’. The cancellation of S2’s share capital might be a disposal by H, but it is not a disposal to another company in the group. Therefore, TCGA 1992, s 171 does not apply and TCGA 1992, Sch 7AC, para 6 is not in point. That being the case, absent TCGA 1992, s 127, we have a disposal to which the substantial shareholding exemption applies and an issue of shares to a connected party, which will be at market value by virtue of TCGA 1992, ss 17 and 18. The effect is that company H has a base cost in the shares of company S2 equivalent to the market value of those shares at the time of the reorganisation. Readers may rightly consider this to be a slightly peculiar result, given the fact that it provides a way for a company regularly to refresh the base cost of its subsidiaries merely by having some kind of internal reorganisation, a result that was unlikely to have been intended by the draftsman or by Parliament.

CONCLUSION 11.9 We hope that this chapter will help readers through the difficulties of interpreting the interactions between the reorganisations provisions that are deemed to apply in respect of certain transactions and the substantial shareholding exemption. In our view, TCGA 1992, Sch 7AC, paras 4 and 6 are an attempt to achieve a sensible result as suggested by the discussions on policy 278

Interaction with substantial shareholding exemption 11.9 above. However, given the alternative approach, it appears that the draftsman did not get it quite right and we would not be surprised if this interaction were to be the subject matter of a tribunal hearing or court case in due course. The flow chart which appears overleaf may be of some use in determining the correct answer where both the reorganisation provisions and the substantial shareholding exemption would otherwise appear to be in point.1

1 With grateful thanks to Simon Long.

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11.10 Interaction with substantial shareholding exemption

FLOW CHART 11.10

1 TCGA 1992, Sch 7AC, para 4(1). 2 TCGA 1992, Sch 7AC, para 6(1)(a). 3 TCGA 1992, ss 116(10), 171(3). 4 TCGA 1992, Sch 7AC, para 4(3).

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Chapter 12

Interactions with other legislation

RELIEFS DESIGNED TO ENCOURAGE INVESTMENT 12.1 The Enterprise Investment Scheme, the Seed Enterprise Investment Scheme, Venture Capital Trusts and the Corporate Venturing Scheme are all schemes which offer tax relief aimed at encouraging taxpayers to invest in small, high-risk companies. This chapter assumes a detailed knowledge of the mechanics of each scheme and therefore focuses specifically on the impact a transaction falling within TCGA 1992, s 135 has on the various reliefs.

The Enterprise Investment Scheme 12.2 The Enterprise Investment Scheme (‘EIS’) offers three forms of tax relief for individual taxpayers, namely income tax relief for sums invested in qualifying EIS shares, disposal relief from chargeable gains on the disposal of qualifying EIS shares and deferral relief from capital gains tax on the reinvestment of capital proceeds into qualifying EIS shares. Just as there are numerous conditions which must be satisfied in order for an individual to qualify for EIS relief in the first place, so too are there continuing conditions such that if there is a change in circumstances within a given time of the investment being made, the advantages conferred by EIS relief may be lost. The main such continuing condition in the case of all three reliefs is the requirement that the taxpayer does not dispose of the EIS shares prior to the end of the relevant period. This section therefore considers the case where an individual holds qualifying EIS shares for which he has obtained income tax and/or deferral relief, but then the EIS shares are exchanged for other shares before the expiration of the relevant holding period. The relevant holding period is five years for shares acquired before 5 April 2000 and three years for shares acquired thereafter. Note that the three-year period begins with the later of: ●●

the share issue date; or

●●

the date the company commences a qualifying trade. 281

12.3 Interactions with other legislation This is because relief can be obtained during a pre-trading period as long as the company is undertaking preparatory work to commence trading, and the trade actually commences within two years of the investment. The relevant period can therefore be up to five years in practice.

EIS income tax relief 12.3 ITA 2007, s 209 contains the basic principle that income tax relief will be withdrawn where an individual makes a disposal before the end of the relevant period. This, however, should be read in conjunction with ITA 2007, s 247(3) which states that, in certain prescribed circumstances, a share exchange of the type which would qualify under TCGA 1992, s 135 is not treated as a disposal for the purposes of ITA 2007, s 209. These circumstances are: ●●

the acquiring company (referred to as the ‘new company’) has only previously issued subscriber shares;

●●

the new company acquires all of the shares in the old company;

●●

the consideration for the old shares consists wholly of the issue of shares in the new company;

●●

the description of the new shares must correspond with the description of the old shares;

●●

the new shares must be issued to the holders of the old shares in proportion to their holding of old shares of each description;

●●

before the issue of the new shares, the old company must have issued eligible shares and must have issued the appropriate certificate of eligibility for those shares; and

●●

clearance must be obtained from the Board of HMRC in advance of the transaction that it will not fall foul of the anti-avoidance provisions found at TCGA 1992, s 137.

Provided that the above conditions are satisfied, ITA 2007, s 247(3) states that the exchange of shares shall not be treated as a disposal for the purposes of ITA 2007, s 209 and that the EIS relief which the original shares attracted shall be extended to the new shares. Accordingly, in such a case, there will be no withdrawal of the EIS income tax relief. ITA 2007, s 247(4) can also protect against the loss of relief under ITA 2007, s 185, ie where the company ceases to be independent during period B. The meaning of ‘subscriber shares’ for the purposes of ITA 2007, s 247 was considered in the First-tier Tribunal case of Gregory Finn, Averil Finn, Andrew Cornish and Robin Morris v HMRC [2015] UKFTT 144 (TC). The appellants’ company, PhotonStar LED Limited, was subject to a reverse takeover by 282

Interactions with other legislation 12.5 Enfis Ltd before the termination date of EIS shares, such that it became a 51% subsidiary. The Tribunal found that subscriber shares are the shares issued to those who subscribe to the Memorandum of Association on the company’s initial formation. As Enfis had issued shares subsequent to this, ITA 2007, s 247 could not be used to prevent a loss of relief.

EIS disposal relief 12.4 EIS disposal relief from capital gains tax will be allowed where the shares have been held for the relevant period and income tax relief has not been removed. Accordingly, if a TCGA 1992, s 135 exchange is effected without the income tax relief being withdrawn (ie because it falls within ITA 2007, s 247(3) above) and nothing else happens within the relevant period to cause the EIS income tax relief to be withdrawn, then the gain on the subsequent disposal of the shares will be exempt from capital gains tax. As well as confirming that the entitlement to EIS disposal relief is not withdrawn at the time of the exchange, the taxpayer will also have to ensure that the exchange does not constitute a disposal for capital gains tax purposes. TCGA 1992, s 150A(8) says that TCGA 1992, s 135 does not apply in respect of shares which attract EIS disposal relief. However, TCGA 1992, s 150A(8D) disapplies this in cases where ITA 2007, s 247(3) would apply (as to which see above) and so essentially, if there is no disposal for EIS income tax relief purposes, there will be no disposal for EIS disposal relief purposes either. The shares acquired in exchange for the original shares will stand in the shoes of the original shares as regards base cost, period of ownership and also availability of EIS disposal relief on a subsequent disposal.

EIS deferral relief 12.5 When considering the operation of EIS deferral relief, the first point to ascertain is whether the original EIS shares were acquired before or after 6 April 1998. A key change occurred to the EIS deferral relief from this date in that from this date all gains can be deferred where an individual invests in EIS shares, whereas before this date EIS deferral relief could only be claimed to the extent that EIS income tax relief could be or was claimed. Accordingly, the implications of a TCGA 1992, s 135 type exchange of shares acquired before 6 April 1998 are closely linked to the treatment of such exchanges for income tax relief purposes. The starting point in the case of shares acquired either side of 6 April 1998 is that an exchange is a disposal which is a chargeable event causing the deferred gain to crystallise (TCGA 1992, s 150A(8), Sch 5B, para 3(1)). The following sections highlight the situations in which this will not be the case. 283

12.6 Interactions with other legislation Original EIS shares issued before 6 April 1998 12.6

The exchange will not be treated as a disposal in the following cases:

●●

if the exchange is one that would fall within the scope of ITA 2007, s 247(3), then TCGA 1992, s 150A(8D) offers a similar relief from the deferred gain crystallising. The shares in the new company will stand in the shoes of the shares in the old company;

●●

where the conditions in TCGA 1992, s 150A(8A)–(8C) are met. These conditions require: (a) the new shares are new ordinary shares carrying no present or future preferential rights as to dividends, assets on a winding up or redemption; (b) the new shares are issued after the end of the relevant period (ie after the fifth anniversary of the issue of the original shares); (c) at some time before the issue of the new shares the company issuing them issued eligible shares and that company had issued an appropriate certificate in respect of those shares in accordance with ITA 2007, s 204.

Original EIS shares issued on or after 6 April 1998 12.7 In the case of shares issued after 6 April 1998, we have to consider shares which attracted EIS income tax and deferral relief and shares which attracted EIS deferral relief only. EIS income tax and deferral relief 12.8 The two exemptions mentioned above apply to exchanges of EIS shares acquired after 6 April 1998 with the modification that the ‘relevant period’ referred to in TCGA 1992, s 150A(8B) will be the third anniversary of the acquisition of any shares acquired on or after 6 April 2000. EIS deferral relief only 12.9 The deferred gain will not come back into the charge to tax in the following two circumstances: ●●

the only issued shares in the new company are subscriber shares and it acquires all of the shares in the old company;

the consideration for the old shares consists entirely of the issue of shares in the new company;

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Interactions with other legislation 12.11

the consideration for new shares of each description consists wholly of old shares of the corresponding description;

the new shares are issued to the holders of the old shares in proportion to their holding of the old shares; and

the exchange would be treated as not involving a disposal by virtue of TCGA 1992, s 127 (TCGA 1992, Sch 5B, para 8(1));

●●

at some time before the issue of the new shares the company issuing them issued eligible shares and that company had issued an appropriate certificate in respect of those shares in accordance with ITA 2007, s 204;

the new shares are new ordinary shares carrying no present or future preferential rights as to dividends, assets on a winding up or redemption; and

the new shares are issued after the end of the relevant period (ie after the fifth anniversary of the issue of the original shares if this was before 6 April 2000 or the third anniversary if the issue was on or after 6 April 2000).

The Seed Enterprise Investment Scheme 12.10 The Seed Enterprise Investment Scheme (‘SEIS’) was introduced in April 2012. It is broadly similar to the EIS but aimed at promoting investment in start-up companies. It is therefore more heavily restricted than the main EIS. For example, the maximum permitted investment a single company can raise via SEIS in any three-year rolling period is just £150,000. The qualifying trade must be no more than two years old, and the gross assets of the company immediately preceding the investment cannot exceed £200,000 (in contrast to £15 million under EIS). However, TCGA 1992, s 135 is still relevant to SEIS shares. The continuing requirements for SEIS are the same as discussed for EIS above, ie shares must not be disposed of prior to the end of the three-year relevant period. However, for SEIS the end of the relevant period is always the third anniversary of the share issue date, even if the company is still preparing to carry on a trade at the investment date.

SEIS income tax relief 12.11 The statutory provisions governing the situation where a company, having issued shares under SEIS, is taken over by another company are largely identical to those for the EIS discussed at 12.3. ITA 2007, s 257HB contains the basic principle that SEIS income tax relief will be withdrawn where an individual makes a disposal before the end of the relevant period. This, however,

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12.12 Interactions with other legislation should be read in conjunction with ITA 2007, s 257HB(3) which states that, in certain prescribed circumstances, a share exchange of the type which would qualify under TCGA 1992, s 135 is not treated as a disposal for the purposes of ITA 2007, s 257FA. These circumstances are: ●●

the acquiring company (referred to as the ‘new company’) has only previously issued subscriber shares;

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the new company acquires all of the shares in the old company;

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the consideration for the old shares consists wholly of the issue of shares in the new company;

●●

the description of the new shares must correspond with the description of the old shares;

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the new shares must be issued to the holders of the old shares in proportion to their holding of old shares of each description;

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before the issue of the new shares, the old company must have issued eligible shares and must have issued the appropriate certificate of eligibility for those shares; and

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clearance must be obtained from the Board of HMRC in advance of the transaction that it will not fall foul of the anti-avoidance provisions found at TCGA 1992, s 137.

Provided that the above conditions are satisfied, ITA 2007, s 257HB(3) states that the exchange of shares shall not be treated as a disposal for the purposes of ITA 2007, s 257FA and that the EIS relief which the original shares attracted shall be extended to the new shares. Accordingly, in such a case, there will be no withdrawal of the SEIS income tax relief. As for EIS, ITA 2007, s 257HB(4) also protects against relief being withdrawn due to the independence requirement at ITA 2007, s 257DG.

SEIS disposal relief 12.12 Where SEIS relief is given and not withdrawn by the end of the relevant period, ie three years from the date of the share issue, then any gain realised on a subsequent disposal will be exempt from capital gains tax under TCGA 1992, s 150A. Ordinarily, if a gain is realised on a disposal taking place before the end of the relevant period, it will be fully taxable. However, if a TCGA 1992, s 135 exchange is effected without the income tax relief being withdrawn (ie because it falls within ITA 2007, s 257HB(3) above) and nothing else happens within the relevant period to cause the SEIS income tax relief to be withdrawn, then the gain on the subsequent disposal of the shares will be exempt from capital gains tax.

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Interactions with other legislation 12.14 Broadly, if there is no disposal for SEIS income tax relief purposes, there will be no disposal for SEIS disposal relief purposes either. The shares acquired in exchange for the original shares will stand in the shoes of the original shares as regards base cost, period of ownership and also availability of EIS disposal relief on a subsequent disposal.

SEIS reinvestment relief 12.13 Where an SEIS investment is made, an investor can choose to match it to gains made in the same year the shares are acquired or are treated as acquired. The matched gains are then reduced by the relevant percentage. The relevant percentage is 50% from 6 April 2013 (100% prior to this). The applicable legislation for this reinvestment relief is contained in TCGA 1992, Sch 5BB and is not discussed at length here. One of the requirements is that income tax relief must be claimed and not withdrawn before the end of the relevant period. If a TCGA 1992, s 135 takeover occurs and ITA 2007, s 257HB applies such that the disposal of shares during the takeover is not treated as a disposal for the purposes of ITA 2007, s 257FA, it follows that there will be no clawback of reinvestment relief either.

Venture Capital Trusts 12.14 The Venture Capital Trust (‘VCT’) scheme allows individuals who are attracted to the idea of investing in small, high-risk companies the opportunity to spread the risk of such an investment by investing in an entity (the VCT) which makes diverse investments under the supervision of professional managers. An additional attraction to this scheme, as opposed to the EIS scheme, is that it facilitates such an investment for individuals who would otherwise struggle to find suitable companies in which to invest. The individual investor can obtain tax reliefs for his investment similar to those offered to the EIS investor and again a working knowledge of the scheme is assumed. This section considers the effect of a share exchange which would otherwise fall within TCGA 1992, s 135 on the following VCT reliefs: ●●

‘front end’ income tax relief;

●●

distribution relief;

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capital gains disposal relief;

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capital gains deferral relief, repealed for shares issued on or after 6 April 2004, by FA 2004, so not covered further in this edition.

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12.15 Interactions with other legislation In the case of a VCT, the exchange could be at one of two levels: the qualifying investments owned by the VCT may be exchanged for shares in a different company in the event that the company invested in is taken over or the VCT shares held by the individual taxpayer may be exchanged for shares in a different company in the event that the VCT itself is taken over.

Exchange of shares owned by the VCT 12.15 In order to qualify as a VCT, the company must have, and continue to have, at least 80 per cent (70 per cent prior to 6 April 2019) of its investments in qualifying holdings. The issue to address here, therefore, is whether an exchange of a qualifying holding for another holding will dilute the proportion of qualifying holdings held by the VCT, thereby resulting in the loss of the VCT status, thus causing the withdrawal of each of the four reliefs available to the individual mentioned above (as well as the loss of the reliefs the VCT scheme offers to the VCT itself). If the shares received in exchange for the original qualifying holding are shares such as would constitute a qualifying holding themselves, then the new shares effectively stand in the shoes of the original shares (ITA 2007, s 327). Clearance must be obtained from the Board in advance of such a transaction. If the shares are not shares which would otherwise comprise a qualifying holding, then the percentage of qualifying holdings will be diluted which may lead to a loss of VCT status. The Treasury does have power under ITA 2007, s 330 to make regulations which would allow the new shares to be treated as a qualifying holding for the purposes of ascertaining whether the 80 per cent test is met, although no such regulations have yet been made. A final point to note is the ‘new holding company’ exception in ITA 2007, s 326. If there is a commercial need for the qualifying company invested in to create a new holding company, then the VCT’s holding in the new holding company will be treated as qualifying to the extent that the old holding qualified. This conclusion will follow provided that the following conditions are met: ●●

the consideration for the old shares consists wholly of the issue of shares in the new company;

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at the time of the exchange, there are no issued shares in the new company other than the original subscriber shares;

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the old shares and the new shares are of the same description and are issued to the holders of the old shares in proportion to their original holdings;

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the Board has issued a clearance under TCGA 1992, s 138(1). 288

Interactions with other legislation 12.19

Exchange of shares in the VCT owned by the individual ‘Front end’ income tax relief 12.16 The basic rule is that front end income tax relief will be withdrawn if an investor disposes of his VCT shares within five years of acquisition (ITA 2007, s 266). While TCGA 1992, s 127 says that a reorganisation does not involve a disposal, s 127 only applies for the purposes of chargeable gains and so does not extend to income tax relief. Furthermore, there is no provision similar to that found in ITA 2007, s 247(3) which provides that an exchange is not a disposal in certain cases. Accordingly, if an individual exchanges his VCT shares for non-VCT shares, then his income tax relief will be clawed back in accordance with ITA 2007, s 266 (loss of relief if shares disposed of within 5 years) and ITA 2007, s 270. Distribution relief 12.17 As soon as the shares cease to be shares in a VCT, then any dividends paid thereon will cease to be eligible for distribution relief. Disposal relief 12.18 If the new holding does not comprise VCT shares, then a disposal will be deemed to take place at market value at the date of the exchange.

The Corporate Venturing Scheme 12.19 FA 2000, Sch 15, para 82 contains the basic rule that TCGA 1992, s 135 will not apply to a reconstruction where the original shareholding had attracted Corporate Venturing Scheme investment relief. Accordingly, there will be a disposal upon exchange and, if this happens within the qualifying period, the existing investment relief will be withdrawn. Furthermore, loss relief or deferral relief will not be available in such cases. The above rule is subject to FA 2000, Sch 15, para 83 which provides an exemption from the rule in the case of an exchange which creates a new holding company. In order to fall within this paragraph, the following requirements have to be met: ●●

the consideration for the old shares must consist entirely of new shares in the new company;

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12.20 Interactions with other legislation ●●

these shares must be of the same description as the old shares and must be issued to holders of the old shares in the same proportion as the old shareholding;

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at the time of the issue of the new shares, the issuing company had no other issued shares other than subscriber shares and new shares previously issued in consideration of old shares;

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HMRC has given an advance approval notification that it is satisfied that the exchange will be effected for commercial reasons and will not form part of a scheme which has tax avoidance as one of its main purposes.

In cases where the above requirements are met, there will be no disposal (per TCGA 1992, s 127) and the new shares effectively stand in the shoes of the old shares and the relief continues to apply (FA 2000, Sch 15, paras 85–87). It should be noted that the Corporate Venturing Scheme’s ten-year period expired on 31 March 2010, and it has not been renewed. Consequently it shall not be available for investments made after that date.

Investors’ relief 12.20 Finance Act 2016, Sch 14 sets out a new relief for investors in unlisted companies. This new relief is designed to operate separately from, and where appropriate, in addition to, the existing business asset disposal relief (formerly known as ‘entrepreneurs’ relief’). The benefit of the relief is that the rate of capital gains tax for disposals of qualifying shares is 10 per cent for lifetime gains of up to £10m. The qualifying conditions of this new relief are in several important respects different from those of the business asset disposal relief – significantly, neither the investor nor a connected person can be an officer or employee of the company or a connected company – but there is the familiar three-year holding period to comply with, and that regard it is relevant to note for present purposes that specific reorganisation provisions have been included as new TCGA 1992, ss 169VN–169VT as inserted by Finance Act 2016, s 87 and Sch 14. Where there is a reorganisation within the terms of TCGA 1992, s 126 involving shares that are within the terms of the relief, the holding is deemed to be continued. There are provisions that determine how to treat a proportionate disposal when some only of the shares are involved in the reorganisation. There are similar provisions governing share for share exchanges under TCGA 1992, s 135, and reconstructions under TCGA 1992, s 136. If in these circumstances the investor wishes instead to realise a disposal, the investor may elect instead to disapply the TCGA 1992, s 135 or 136 treatment.

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Interactions with other legislation 12.21

CONCLUSION 12.21 There is no real message to this chapter. What we see in all these interactions is adaptation of the basic rules for reorganisations and reconstructions in the context of new legislation being introduced. In this case, the various pieces of legislation have been introduced with a view to encouraging investment in new businesses, so the reorganisation provisions have been adapted so as not to dilute the impact of these tax incentives, while also preventing abuse of the rules to gain tax advantages not intended by Parliament.

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Chapter 13

Reorganisations: Anti-avoidance and clearances

INTRODUCTION Avoidance schemes 13.1 The share exchange rules were soon discovered to be a fruitful way to avoid tax on disposals of companies by their shareholders. For example, shareholders would carry out a share-for-share exchange with a non-UK resident company, as a tax-free transaction under TCGA 1992, s 135. The original company could then be sold and, assuming the new holding company was resident in a country with no tax on corporate chargeable gains, the disposal was tax-free. This left the shareholders owning a non-UK resident cash box company and various ingenious methods were used to extract the cash to the benefit of the shareholders without generating a UK tax charge. This particular form of avoidance became particularly well known as part of the developing ‘Ramsay doctrine’. Whether this new approach could be applied to this sort of transaction was debated by the courts on several famous occasions. The seminal House of Lords cases in this area are Floor v Davis 52 TC 609, decided in 1979, Furniss v Dawson 55 TC 324, decided in 1984, and Craven v White 62 TC 1, decided in 1988. These cases straddle the decision in WT Ramsay Ltd v IRC 54 TC 101, where judgment was given by the House of Lords in 1981.

Floor v Davis 13.2 In Floor v Davis, Major Floor and his two sons-in-law owned all the shares in IDM Electronics Ltd (‘IDM’). Having agreed to sell IDM to a third party, KDI, which was US resident, they first sold IDM to a newly incorporated company, FNW Electronics Holdings Ltd (‘FNW’), the consideration being the issue to the shareholders of preference shares in FNW. The following day, FNW sold its IDM shares to KDI (see Figure 13.1).

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Reorganisations: Anti-avoidance and clearances 13.2 Figure 13.1 Floor v Davis 52 TC 609

The planning was technically robust; there had been a share-for-share exchange within the meaning of what is now TCGA 1992, s 135 and the Crown could not impeach the transaction on those grounds. However, Peter Millett QC for the Crown also argued that the disposal should be treated for tax purposes as though it had taken place directly by the shareholders in IDM to the third party, KDI, so that the exchange with FNW should be ignored for tax purposes. The short time frame in which the disposals took place and the fact that the sale of the shares to KDI would inevitably follow the transfer of shares to FNW would have influenced the Crown to take this position. The other argument put to support the Crown’s view was that the intermediate company, FNW, never had control of IDM as it was effectively bound to sell the shares directly to KDI. However, this argument was dismissed in the High Court on the basis that there was no evidence that there was any kind of enforceable agreement for FNW to sell the shares immediately. In any case, since Major Floor and his sons-in-law controlled FNW, they were able to compel the company to sell the shares without the need for any agreement to be in place before the exchange. On Peter Millett’s argument, the Crown failed, although Eveleigh LJ found the argument compelling in the Court of Appeal. In a slightly salacious analogy (especially for those days!), he said: ‘If a man wished to sell his house to his mistress at an artificially low price and conceal it from his wife, he might with the co-operation of a friend who held a controlling interest in a company sell the house to the company at that low price in the knowledge that his friend would ensure that the house was sold to the mistress. There would be no legal obligation on the company to do this. Nonetheless in my opinion the original owner would have disposed of his house to his mistress.

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13.3 Reorganisations: Anti-avoidance and clearances Qui facit per alium facit per se1 is a maxim which does not depend on contractual relationship of principal and agent. A man may act through the hand of another whose conduct he manages to manipulate in some way and whether or not he has so acted is often a question of fact to be considered by looking at all that is done. I see this case as one in which the court is not required to consider each step taken in isolation. It is a question of whether or not the shares were disposed of to KDI by the taxpayer. I believe that they were. Furthermore, they were in reality at the disposal of the original shareholders until the moment they reached the hand of KDI, although the legal ownership was in FNW’. Nevertheless, it was held that the disposal of the IDM shares to FNW could not be ignored. Although the intermediate step was not a disposal for tax purposes that gives rise to an immediate profit or loss, the legislation does not provide that the transfer can be ignored altogether, given that it has wider economic implications to various parties. Although Eveleigh LJ’s was a minority view in the Court of Appeal and the point was not argued in the House of Lords2 his comments resonate with the 1981 House of Lords judgment in Ramsay when Lord Wilberforce said: ‘On these facts it would be quite wrong, and a faulty analysis, to pick out, and stop at, the one step in the combination which produced the loss, that being entirely dependent upon, and merely a reflection of the gain. The true view, regarding the scheme as a whole, is to find that there was neither gain nor loss, and I so conclude’.

1 ‘Who does something through others does it himself’. 2 In fact, in Floor v Davis, the Revenue won on a different point concerned with the eventual disposition of FNW with the cash.

Furniss v Dawson 13.3 In the very similar case of Furniss v Dawson, the shareholders controlled two companies, Fordham and Burton Ltd (‘F&B’) and Kirkby Garments Ltd (‘KG’). Having agreed to sell the companies to WBH, a third party, an exchange was first carried out with an Isle of Man company, Greenjacket Ltd, which sold F&B and KG on to WBH on the same day. Thus, as in Floor v Davis, the gain was taken offshore (see Figure 13.2).

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Reorganisations: Anti-avoidance and clearances 13.3 Figure 13.2 Furniss v Dawson 55 TC 324

Following its success in Ramsay in getting the courts to look more closely at the substance of transactions, rather than purely at the legal form, and to decide on the tax consequences of a scheme as a whole, rather than taking a detailed, step-by-step view, the Revenue again argued that schemes like this must be looked at as a single composite transaction of sale by the original shareholders to the eventual purchaser.1 In the House of Lords, the Crown’s view was upheld unanimously. Lord Brightman approved an earlier formulation that: ‘First, there must be a pre-ordained series of transactions or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (ie business) end. The composite transaction does in the instant case; it achieved a sale of the shares in the operating companies by the Dawsons to Wood Bastow. It did not in Ramsay. Secondly, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax – not “no business effect”. If those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied’. Lord Bridge of Harwich said: ‘When one moves, however, from a single transaction to a series of interdependent transactions designed to produce a given result, it is, in my opinion, perfectly legitimate to draw a distinction between the substance and the form of the composite transaction without in any way suggesting that any of the single transactions which make up the whole are other than genuine’. This acceptance that the substance, rather than the legal form, can be important would appear to be an exact reversal of the 1935 House of Lords decision in 295

13.4 Reorganisations: Anti-avoidance and clearances IRC v Duke of Westminster 19 TC 490, where the substance over form argument was comprehensively rejected, although the Westminster case has never been explicitly overruled by the House of Lords. Noting the importance of the Furniss v Dawson decision three years after Ramsay, Lord Bridge of Harwich said: ‘the present appeal marks a further important step, as a matter of decision rather than mere dictum, in the development of the courts’ increasingly critical approach to the manipulation of financial transactions to the advantage of the taxpayer’. As an aside, one might ask how different UK tax jurisprudence might have been if the judiciary had followed the US example of Helvering v Gregory 69 F2d 809 (1934), affirmed in 293 US 465 (1935). This is the well-known case where Learned Hand J looked at a transaction almost identical to those in Floor v Davis and Furniss v Dawson, for which a similar relief existed in the US, and took a purely purposive stance: ‘we cannot treat as inoperative the transfer of … shares by [A] [or] the issue by [B] of its own shares … [B] had a juristic personality … All these steps were real and their only defect was that they were not what the statute means’. That is, while there was a reorganisation, this was not the sort of reorganisation that Congress had intended to relieve in this way as it had no business purpose.

1 Again, it is interesting to consider the personalities involved: Stephen Oliver QC, who before his retirement was Acting President of the Tax Chamber of the First-tier Tribunal, appeared for the taxpayers and Peter Millett QC, now retired as a Lord Justice of Appeal, led for the Crown, assisted by Robert Carnwath, who is now a Supreme Court Judge and was involved, inter alia, with the Court of Appeal decision in BMBF v Mawson 76 TC 446.

Craven v White 13.4 This case was almost identical to the previous two: Archibald, Stephen (Archibald’s nephew) and Brian (Archibald’s son) White together owned a company called Queensferry, which carried on a greengrocery business with 12 supermarkets. The Whites intended to sell the company or possibly to merge it with another but first sold it to Millor Investments Ltd, a company set up in the Isle of Man. At that time it was not certain whether the potential merger partner would also be sold to Millor Investments to form a larger group, or whether Millor would, instead, sell Queensferry to Morris & David Jones Ltd (Jones), which is what eventually happened. By a 3:2 majority, their Lordships decided that the Ramsay principle could not apply in this case, because of the uncertainty about the final disposition of Queensferry, ie it could not be said that there was a pre-ordained series of transactions.

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Reorganisations: Anti-avoidance and clearances 13.6 The main impact of this case was that tax-mitigating structures or arrangements were generally put in place before a company was marketed. That way, there could never be a pre-ordained series of transactions and the development of the Ramsay anti-avoidance principle was effectively checked for a number of years.

The result of the cases 13.5 The detailed development of the Ramsay doctrine is a matter for a different book. But it was clear that these schemes all relied on the ability to carry out tax-free share exchanges, even when the ultimate purpose was avoidance of capital gains tax and the exchange had no other purpose, which was clearly the situation in Floor v Davis and Furniss v Dawson (arguably, there was a commercial purpose in Craven v White, to form a larger group). The legislative response was to introduce a requirement for a business purpose before the relief could be given, together with a requirement that there was no intention to avoid capital gains tax, income tax or corporation tax. The tests, introduced in 1977, are now found in TCGA 1992, s 137(1), and were introduced to apply to exchanges (TCGA 1992, s 135), as well as to the reconstruction reliefs (TCGA 1992, ss 136 and 139 discussed in Part 4 of this book). Similar tests, together with the associated clearance provisions now found in TCGA 1992, ss 138 and 139(5), and in CTA 2009, s 831, had previously been used for the purposes of the transactions in securities legislation (now at ITA 2007, s 682 et seq and CTA 2010, s 731 et seq, originally introduced, as an anti-avoidance measure, as FA 1960, s 28). So the tests and their operation were not entirely novel, although their application to a wider range of taxes and transactions caused a degree of consternation in the House of Commons when the 1977 Finance Bill was being debated.1 Let us now look at the legislation.

1 See, for example, the Standing Committee debates of 20 and 21 June 1977, cols 909 et seq.

THE LEGISLATION 13.6 The legislation has two main purposes here. First, and most important in the context of the jurisprudence discussed above, is the imposition of the commercial purpose test, alongside a requirement that the transaction must not be motivated by tax avoidance. Secondly, we have provisions for the collection of tax where the person assessed as a result of failing one (or both) of these tests also fails to pay the tax. 297

13.7 Reorganisations: Anti-avoidance and clearances TCGA 1992, s 137(1) – the main test 13.7 ‘(1) Subject to subsection (2) below, and section 138, neither section 135 nor section 136 shall apply to any issue by a company of shares in or debentures of that company in exchange for or in respect of shares in or debentures of another company unless the exchange or scheme of reconstruction in question is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to capital gains tax or corporation tax.’ Analysis 13.8 This is the business purpose test referred to in the introduction. There are two legs to the test: first, the relief under TCGA 1992, ss 135 and 136 cannot apply unless the transaction is carried out for bona fide commercial reasons and, secondly, the relief cannot apply if the transaction forms part of a scheme or arrangements with a main purpose of avoiding capital gains tax or corporation tax. Note, very importantly, that this legislation applies to reconstructions and transactions within TCGA 1992, s 136, as well as to deemed reorganisations within TCGA 1992, s 135. Also, per TCGA 1992, s 137(6), the legislation applies to interests of members in companies or options over shares that are brought into the reorganisations provisions by virtue of TCGA 1992, s 135(5), 136(5) or 147 (quoted options issued in a reorganisation).

Bona fide commercial reason test 13.9 The scope of the bona fide commercial reasons test has been tested by the courts, mainly in the context of cases relating to the transactions in securities legislation, and the range has been found to be wide enough to encompass, for example, the wider commercial requirements of the shareholders1 or the need to prevent a major supplier going out of business by preventing it being acquired by asset strippers.2 These days, HMRC does not always accept such a range of circumstances to be bona fide commercial. However, in the case of Trevor G Lloyd v HMRC SpC 00672, Mr Lloyd carried out some unusual transactions (for want of a better description), which did not appear to be obviously commercial. The Special Commissioners distinguished between the requirement of the statute, that the 298

Reorganisations: Anti-avoidance and clearances 13.10 transactions be carried out for bona fide commercial reasons, and the question of whether the transactions were, themselves, commercial. They found that it does not matter if the transactions are not obviously commercial, it is the reason for carrying them out that is paramount. More recently, in an unpublished decision, the First-tier Tribunal has suggested that it does not consider the saving of income tax to be a commercial reason. The two shareholders of a company wanted to exchange their shareholdings into personal investment companies, so that each shareholder could effectively take the profits of the trading company tax-free into their personal companies and recycle the money into other projects. To some extent, the authors see this as a presentational issue; in similar cases, HMRC has accepted that the inherent tax efficiency of these arrangements allows the shareholders to maximise the amounts reinvested into new businesses, which is accepted as being commercially driven.

1 In IRC v Clark 53 TC 482. 2 In IRC v Brebner 43 TC 705.

Meaning of ‘tax advantage’ 13.10 ‘Tax advantage’ is not defined in this legislation. We can, of course, infer that some form of comparison is required, ie is there another way of achieving the commercial aim (assuming that there is one) which carries a higher tax charge? This does not mean that taxpayers will be considered to be avoiding tax if they choose a more tax-efficient transaction over a less tax-efficient one, as that would be a complete negation of the postulate that a person is entitled to structure their affairs in a tax-efficient manner,1 but HMRC might well consider there to be a tax avoidance motive for entering into a complex series of transactions involving a reorganisation or reconstruction and which generate a smaller tax bill than would have been the case for a simpler transaction. In a similar context, HMRC has stated that they will look at ‘whether the objective is being fulfilled in a straightforward way or whether the introduction of any additional complex or costly steps would have taken place were it not for the tax advantage that could be obtained’.2

1 See, in particular, Duke of Westminster v CIR 19 TC 490 and IRC v Brebner 43 TC 705. 2 Paragraph 12 of the Guidance Notes on ‘Avoidance Through the Creation and Use of Capital Losses by Companies’ published on 22 March 2006.

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13.11 Reorganisations: Anti-avoidance and clearances

Main purpose or one of the main purposes 13.11 The test of whether the motivation is wholly or mainly tax avoidance is becoming more and more important as it appears in one form or another in a number of areas of the tax legislation. It has also been considered extensively by the courts and, again, this has been largely in the context of cases involving the transactions in securities legislation. We are fortunate, however, to have two pairs of contrasting cases to demonstrate the range of this test. In Marwood Homes No 1 Ltd v IRC [1997] STC (SCD) 37, the Special Commissioners found on the facts presented to them that a series of transactions were undertaken for mixed commercial and tax reasons. The Commissioners concluded that, although it was a finely balanced case, the motivation had been mainly commercial and there was not a whole or main purpose of tax avoidance. This decision is contrasted with Marwood Homes No 3 Ltd v IRC [1999] STC (SCD) 44, when the identical case was reheard by the Tribunal constituted under ICTA 1988, s 706 (now repealed). The Tribunal was made aware of a note of a meeting which referred to ‘beefing up’ the commercial rationale for the transactions. The Tribunal decided that this meant that the transactions had a main purpose of avoiding tax, effectively because they inferred that there was not originally an adequate commercial reason for the transactions. In the judgment, the Tribunal stated that ‘if one or more of the specified transactions can be explained as having its main objective (or one of its main objectives) the obtaining of a tax advantage, the obtaining of that tax advantage may disqualify the transactions … from the bona fide commercial limb of the escape clause’. A contrast can also be drawn between Lewis (Trustee of Redrow Staff Pension Scheme) v IRC [1999] STC (SCD) 349 and IRC v Sema Group Pension Scheme Trustees 74 TC 593. In Lewis, the trustee of a pension fund sold shares back to a company and was aware of an associated tax advantage, but there was a compelling regulatory requirement to reduce the fund’s holdings in those shares. Conversely, in Sema, the trustees accepted the buy-back offer from the company because of the tax advantage. Absent that advantage, they would not have sold the shares back to the company as there would have been a loss on the transaction. The overall conclusion is to recognise that taxpayers have a right to be aware of the tax consequences of the actions they take. Indeed, in the case of companies, the directors have an obligation to shareholders and creditors to consider the tax consequences and it may also be that a transaction does give rise to a tax advantage. However, so long as the transaction was carried out for bona fide commercial reasons and a main intention was not to avoid tax, in theory, the taxpayer should be safe from challenge by HMRC. The fact that the transaction

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Reorganisations: Anti-avoidance and clearances 13.13 generates a tax advantage does not (and cannot) be taken to mean that tax was a prime motive for the transactions. As Lord Upjohn said in Brebner: ‘… when the question of carrying out a genuine commercial transaction, as this was, is considered, the fact that there are two ways of carrying it out − one by paying the maximum amount of tax, the other by paying no, or much less, tax − it would be quite wrong as a necessary consequence to draw the inference that in adopting the latter course one of the main objects is, for the purposes of the section, avoidance of tax. No commercial man in his senses is going to carry out commercial transactions except upon the footing of paying the smallest amount of tax involved.’ Unfortunately, in practice, certainly in recent years, we are generally of the view that the HMRC clearance team assume that intention and effect are the same. That said, the tribunals seem able to maintain the distinction, as we saw above, in the Trevor Lloyd case.

The Snell case 13.12 Snell v HMRC [2006] All ER (D) 336 is a useful recent case that brings out the scope of the two tests in TCGA 1992, s 137(1), the bona fide commercial test and the tax avoidance test. Mr Snell sold his shares in his family company in December 1996, for a consideration of £7.3 million, of which £6.6 million was in loan stock. On 2 April 1997 he left the UK to live abroad permanently, becoming non-resident for tax purposes. In July 1997, the loan stock was redeemed. Mr Snell claimed that the gain on his shares could be ‘rolled over’ into the loan stock, under TCGA 1992, s 135, so that no gain arose in 1996/97, when he was UK-resident. Instead, the gain arose when the loan stock was redeemed and when Mr Snell was no longer UK resident. The issue considered by the Special Commissioners and the High Court was whether Mr Snell failed the tests of TCGA 1992, s 137(1). That is, was the exchange ‘effected for bona fide commercial reasons’ and did it ‘form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to capital gains tax’?

Bona fide commercial reason 13.13 The first question was therefore whether the transaction was carried out for bona fide commercial reasons. It was argued for Mr Snell that the legislation only required there to have been a bona fide commercial reason 301

13.14 Reorganisations: Anti-avoidance and clearances for selling his shares in return for loan stock. Counsel for HMRC contended that the bona fide commercial reason had to encompass not just the sale of the shares but also the reasons for taking the consideration in the form of loan stock, rather than in cash, shares or any other form. The Special Commissioners agreed with Mr Snell’s position, saying that: ‘We consider that one should take the actual transactions carried out, here the sale of shares to a third party in exchange for three different types of loan stock, and ask whether that was carried out for bona fide commercial reasons.’ They found that it was and the High Court agreed with their position, noting that there was no need to look at the alternative transactions when there is a perfectly good anti-avoidance test anyway. The judge, Sir Andrew Morritt said: ‘I can see no reason why Parliament should have been concerned with whether the same result might have been achieved by some other legal form or means. This is particularly so when the same subsection introduces a non-avoidance test by reference to the scheme or arrangements as a whole. In my judgment this conclusion is confirmed by the wording of the subsection. The question is whether “the exchange in question is effected for bona fide commercial reasons”. If the answer is in the affirmative it is irrelevant to consider the reasons why the parties chose to structure their transaction in that way.’ So the result here is that the bona fide commercial test looks at the wider commercial reason for the transaction and does not concern itself with the detail. It is about why the shares were sold, not why they were sold for consideration in that particular form.

Tax avoidance motive 13.14 On the tax avoidance test, the judge considered whether there was a scheme or arrangements and then whether these had a tax avoidance purpose. A great deal of evidence had been given, both oral and documentary, as to whether Mr Snell intended to become non-resident at the time the business was sold, and as to whether this was why the consideration for the share sale was in the form of loan notes. The Special Commissioners considered on the evidence that Mr Snell ‘intended, at least on the balance of probabilities, to become non-resident for the purpose of redeeming loan stock on an eventual sale … and accordingly that one of his main purposes (indeed the only main purpose) of effecting the arrangements was avoidance of capital gains tax’. 302

Reorganisations: Anti-avoidance and clearances 13.16 In the High Court the terms of the test were considered in detail. A scheme was noted to be ‘a plan of action devised in order to attain some end’ and an arrangement was ‘a structure or combination of things for a purpose’.1 So if there was a plan of action or combination of elements linking Mr Snell’s becoming non-resident with the acceptance of loan notes on that day with their redemption when non-resident, this would form a relevant scheme or arrangements. The fact that Mr Snell had not definitely made up his mind to go abroad when he accepted loan notes was considered irrelevant to the question of whether there had been a scheme or arrangements. So the only remaining question was whether the scheme or arrangements were intended to avoid capital gains tax, and the only inference to be drawn from the facts was that capital gains tax avoidance was the only possible purpose of the scheme or arrangements.

1 Both from the Shorter Oxford English Dictionary.

Significance of Snell 13.15 This is an important case, in that it gives some helpful guidance as to the meanings of the tests that appear in TCGA 1992, s 137(1), as well as elsewhere in the tax legislation. First, we are told that the bona fide commercial test is to be applied in the context of the wider transaction alone and not in the context of whether that transaction could have been carried out in a different way. It is the tax avoidance test that is then used to consider why the transaction was carried out in the way that it was. And this case is helpful in explaining what a scheme or arrangements are, and how the courts might approach the question of whether a scheme or arrangements may have a tax avoidance motive.

Whose motivation? 13.16 In Brebner, the Revenue had apparently argued that there could not be a bona fide commercial reason for the transactions by the company as the company would be indifferent to how its assets were distributed. In the House of Lords, Lord Pearce said that: ‘The “object” which has to be considered is a subjective matter of intention. It cannot be narrowed down to a mere object of a company, divorced from the directors who govern its policy or the shareholders who are concerned in and vote in favour of the resolutions … the company, as such, and apart from these, cannot form an intention’. 303

13.17 Reorganisations: Anti-avoidance and clearances So the motivation we are looking at in these cases will generally be those of the directors or the shareholders (and in cases like Clark, they will often be the same people). In IRC v Addy 51 TC 71, it was suggested that it might sometimes be appropriate to consider the intentions of the professional advisers, but this goes too far, in our opinion, as it suggests that the professional advisers might be acting almost as shadow directors. Perhaps the best recent formulation was that in Marwood Homes No 3, where the Tribunal said that the intention to be looked at is that of ‘… those who govern the policy of the company in the area where the transaction or transactions in question fall’.

Who is affected? 13.17 The courts have also considered the question of whether all shareholders are caught by these provisions, regardless of their personal intentions. Coll v Commissioners for Revenue & Customs [2010] UKUT 114 (TCC) was a case where the taxpayers were found to fall foul of the tax avoidance test. Mrs Coll argued that she had simply followed her husband’s instructions and had no tax avoidance motive herself. The tribunals held that it was the purpose behind the transactions that counted, not the purpose of the individuals in entering into them. Since the relevant transactions had been designed to avoid capital gains tax, both Mr and Mrs Coll were caught by this rule.

The meaning of ‘corporation tax’ 13.18 The meaning of ‘corporation tax’ in this context has never been considered. However, it seems reasonable to infer that the legislators assumed that this would only apply where what is being avoided is corporation tax on chargeable gains, not general corporation tax on income. That said, it is unlikely that HMRC would ever confirm such a restriction to the scope of what is, after all, anti-avoidance legislation. TCGA 1992, s 137(2) and (3) – restricted application 13.19 ‘(2) Subsection (1) above shall not affect the operation of section 135 or 136 in any case where the person to whom the shares or debentures are issued does not hold more than 5 per cent of, or of any class of, the shares in or debentures of the second company mentioned in subsection (1) above. (3) For the purposes of subsection (2) above shares or debentures held by persons connected with the person there mentioned shall be treated as held by him.’ 304

Reorganisations: Anti-avoidance and clearances 13.21 Analysis 13.20 This provision ensures that it is not necessary for shareholders to consider the anti-avoidance legislation if they hold less than 5 per cent of the company’s share capital or of any one class of share capital. This is intended to relieve small shareholders from this particular compliance burden and it means that, in practice, TCGA 1992, s 137(1) will not apply to public companies, for example, where it is rare that any one shareholder holds 5 per cent of the share capital. That said, the shareholders might still decide to ask for clearance under the transactions in securities legislation, or in the context of other provisions, such as demergers, so the exception does not necessarily remove the need for a clearance application in all cases. The test applies separately to each class of shares, which is important as sometimes small shareholders may have all the shares of a particular class, even though they do not hold anywhere near 5 per cent of the company’s issued share capital. For example, we have seen companies where the executive or employee share option schemes operate by issuing shares of a special class to employees that exercise their options. As a result, although shares issued under the share option schemes constitute a very small proportion of the share capital, the shareholders will each have more than 5 per cent of that particular class of capital. We assume that, at its inception, this provision was meant as an anti-avoidance rule. One might easily construct a scenario where a shareholder distributes 95 per cent of the shares in a private company to various acquaintances so that no one person has a holding in excess of 5 per cent. To avoid losing control or economic rights, it would be necessary to ensure that only the 5 per cent retained had voting power or rights to dividends. If the test did not apply to each class of share, this would be a way around TCGA 1992, s 137(2) for the shareholder concerned. Similarly, TCGA 1992, s 137(3) is an anti-fragmentation rule to prevent shareholders giving their shares to family members or other group companies, etc and getting around the 5 per cent rule that way. ‘Connected’ is defined at TCGA 1992, s 286. TCGA 1992, s 137(4) to (6) – third-party liabilities 13.21 ‘(4) If any tax assessed on a person (the chargeable person) by virtue of subsection (1) above is not paid within six months from [the date determined under subsection (4A) below], any other person who – (a) holds all or any part of the shares or debentures that were issued to the chargeable person; and 305

13.22 Reorganisations: Anti-avoidance and clearances (b) has acquired them without there having been, since their acquisition by the chargeable person, any disposal of them not falling within section 58(1) or 171;

may, at any time within two years from [that date], be assessed and charged (in the name of the chargeable person) to all or, as the case may be, a corresponding part of the unpaid tax; and a person paying any amount of tax under this subsection shall be entitled to recover from the chargeable person a sum equal to that amount together with any interest paid by him under section 87A of the Management Act on that amount.

(4A) The date referred to in subsection (4) above is whichever is the later of – (a) the date when the tax becomes due and payable by the chargeable person; and (b) the date when the assessment was made on the chargeable person. (5) [Amends sub-s (4) and inserts sub-s (4A)] (6) In this section references to shares or debentures include references to any interests or options to which this Chapter applies by virtue of section 135(5), 136(5) or 147.’ Analysis 13.22 These provisions are compliance provisions relating to the collection of corporation tax. The legislation imposes secondary liabilities in situations where the person primarily liable to pay tax fails to do so. In this case, the legislation can only apply if any tax is due from a person following a reorganisation where TCGA 1992, s 137(1) was in point, so that the reorganisation or reconstruction transactions within TCGA 1992, s 135 or 136 were not carried out for bona fide commercial reasons or they were part of a tax avoidance scheme. In that case, tax will be assessed in the first instance on the taxpayer or taxpayers concerned (referred to as the ‘chargeable person’). If that person fails to pay within six months from the relevant date, any unpaid liability can be assessed on any other person that has acquired from the chargeable person any of the shares or debentures issued in the relevant transaction, so long as the other person acquired the shares through a spousal transfer (TCGA 1992, s 58(1)) or through an intra-group transaction (TCGA 1992, s 171(1)). So the secondary liabilities cannot be recovered from a person who merely bought the shares or debentures, for example, or who received them by way of legacy on the death of the chargeable person. The date referred to above, after which HMRC can assess a successor shareholder, is either the due and payable date for the tax to be paid or the date of the assessment on the chargeable person, whichever is the later.

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Reorganisations: Anti-avoidance and clearances 13.23 The legislation also permits the other person to recover the unpaid tax from the chargeable person, together with any interest on unpaid tax that might also have been recovered. Finally, these collection provisions also apply to interests of members in companies or options over shares that are brought into the reorganisations provisions by virtue of TCGA 1992, s 135(5), 136(5) or 147.

CONCLUSION 13.23 We have seen in this chapter how a relief designed to facilitate business transactions was subverted by the tax avoidance industry (for such it was in those days) to the purposes of circumventing the intention of the relief. Although the judiciary eventually overcame their dislike for ‘substance over form’ arguments, deciding for the Revenue in Furniss v Dawson, this was not a wholly satisfactory situation, particularly as, in the later case of Craven v White 62 TC 1 (discussed briefly in Chapter 1), the courts found for the taxpayer as the transactions did not have the required degree of inevitability. In the event, therefore, a two-part test was adapted from older anti-avoidance legislation – the transactions in securities legislation – to require most deemed reorganisation transactions to be motivated by commercial factors and not by tax avoidance before the reorganisation reliefs can apply. This is an example of tax legislation developing by borrowing provisions designed for one use and using them in another, although the 2010 rewrite of the transactions in securities legislation for income tax purposes eliminated the test of commerciality and only requires that the avoidance of income tax is not the main purpose, or one of the main purposes, of being a party to a transaction in securities.

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Chapter 14

Clearances

INTRODUCTION 14.1 The tests introduced in 1977 in what is now TCGA 1992, s 137 were very similar in form and formulation to the tests introduced in 1960 in the transactions in securities legislation1 and were almost certainly adapted from that source. By the same token, it was clear that companies and taxpayers would require certainty that the transactions that they were undertaking would not be challenged under TCGA 1992, s 137(1) where they were carried out for bona fide commercial reasons and not for the avoidance of tax. One way to achieve this degree of certainty is to allow taxpayers to apply in advance to HMRC for a ruling that the transactions proposed are being carried out for bona fide commercial reasons and not for the avoidance of tax. With such a ruling, the taxpayer can confidently carry out the transactions concerned with certainty as to the tax treatment of the transactions. Again, the form of the legislation allowing for the pre-transaction clearances is largely based on the similar provisions introduced in 1960, yet another example of old legislation being adapted for new purposes. Let us now see how the legislation works. The current name of the team dealing with these clearances is BAI Clearance.

1 Now at CTA 2010, s 731 et seq and ITA 2007, s 682 et seq. See Chapter 13 for more detail.

THE LEGISLATION TCGA 1992, s 138(1) – effect of clearance in advance 14.2 ‘(1) Section 137 shall not affect the operation of section 135 or 136 in any case where, before the issue is made, the Board have, on the application 308

Clearances 14.5 of either company mentioned in section 137(1), notified the company that the Board are satisfied that the exchange or scheme of reconstruction will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as are mentioned in section 137(1).’ Analysis 14.3 This subsection disapplies TCGA 1992, s 137(1) in cases where the Board of HMRC has declared itself satisfied that the exchange or scheme of reconstruction will be effected for bona fide commercial reasons and will not form part of a scheme or arrangements for the avoidance of tax. Scope of clearance 14.4 It is important to note the restricted terms of TCGA 1992, s 138(1). The provision only authorises the Board to state that it is satisfied ‘that the exchange or scheme of reconstruction will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as are mentioned in section 137(1)’. It does not give an agreement that the transactions referred to will indeed be a reorganisation or reconstruction within the relevant statutory provisions. These issues are not, in strict law, matters for BAI Clearance, and clearance letters are generally caveated to this effect. For a share exchange, the letter will say that the clearance ‘does not say that Section 135 TCGA 1992 actually applies to any of the proposed transactions. It is concerned only with the conditions for the anti-avoidance rule in Section 137(1) not to apply’. Similar wording is found in clearance letters for schemes of reconstruction, referring to TCGA 1992, ss 136 and 139(1) and the anti-avoidance rules at TCGA 1992, ss 137(1) and 139(5). Who is responsible for determining whether the technical conditions are satisfied? 14.5 Ultimately, that is for us, the advisors, as noted below. But it is interesting to see what HMRC’s Manuals say about these issues. At CG52637, they say that the local officers of HMRC are responsible for determining whether a transaction that purports to be a share exchange strictly qualifies as such for the purposes of TCGA 1992, s 135. But they go on to say that ‘The technical conditions which apply to Section 136 are more complex’, so that the clearance unit will determine whether a transaction or series of transactions amounts to a scheme of reconstruction, as defined in TCGA 1992, Sch 5AA. This is reinforced in CG52763, where they say that ‘To ensure consistency of treatment in what can be a difficult area the clearance team in CounterAvoidance Directorate consider whether a proposed transaction is a scheme of 309

14.6 Clearances reconstruction when dealing with clearance applications’. In fact, the authors understand that, in cases of doubt, the final arbiters of whether the conditions are met for a scheme of reconstruction will be the technical capital gains team, not the clearance unit. In the past, HMRC has undertaken to inform taxpayers in the clearance letters if there is any doubt over whether a transaction constitutes a scheme of reconstruction. This is, indeed, what happens in practice, although we cannot find any reference to this practice in current HMRC Manuals. So, an unqualified clearance application can be assumed to have passed muster as a scheme of reconstruction. It is not clear, however, how far taxpayers can rely on the lack of any qualification to a clearance letter if, when the company return is submitted, the local inspector queries the status of the transaction. And we would certainly not suggest that anyone should rely on the lack of any comment by HMRC on this point. Note, however, that this practice does not apply to share exchanges. Given the comments in CG52637, noted above, it is therefore vital for the advisors to ensure that an exchange qualifies for treatment as a reorganisation, as any challenge will only come when the local officer looks at the relevant tax returns (ie after the transaction has been carried out, so that the tax liability has crystallised). In any case, the authors would always maintain that it is the responsibility of the tax advisors to ensure that transactions qualify as either share exchanges or schemes of reconstruction. Our combined experience is that it is unlikely that the position in either case will be queried by a local office. Who can apply for clearance? 14.6 Either of the companies referred to in TCGA 1992, s 137(1) can make the application, ie either the company being transferred or the company issuing the new shares or debentures. In the original 1977 version, only the company issuing the shares or debentures was entitled to apply for clearance. What is perhaps slightly odd is that, strictly speaking, the shareholders of the company being transferred are not entitled to make an application for clearance under TCGA 1992, s 138, despite being the only likely tax payers in a share exchange, as well as being tax payers in many schemes of reconstruction. So the person most affected by whether or not clearance is granted is strictly not permitted to be party to these proceedings. In practice, however, we have never seen HMRC challenge a clearance application on this basis. The other vital fact to remember here is that a clearance application is not mandatory. TCGA 1992, s 138 is an option that companies can use if they wish, but the fact that a company does not apply for clearance for a transaction does not have any impact on whether TCGA 1992, s 137(1) applies to deny 310

Clearances 14.7 reorganisation treatment for the transaction. Occasionally, HMRC inspectors have forgotten this and have had to be reminded that the reorganisation treatment applies to transactions carried out for bona fide commercial reasons and not for the avoidance of tax, even though the companies did not apply for clearance under TCGA 1992, s 138. Inspectors also occasionally need reminding that a decision not to apply for clearance should not be taken as a prima facie reason that the transactions had some ulterior, non-commercial motive or were carried out to avoid tax. Quite often, transactions are carried out in a short time frame and the parties may not be able to wait up to 30 days for a clearance from HMRC, for commercial reasons. Where the transaction is being carried out for wholly commercial reasons and not to avoid tax, this should be perfectly acceptable. It was refreshing to hear the views expressed1 that it is not necessary for companies to apply for clearance in the simple cases where it is clear that the conditions for reorganisation treatment are satisfied. This would be to the benefit of both business – as companies would not have to spend the time and money making the application – and of HMRC – as the BAI Clearance Team would be able to spend more time on the difficult cases. We assume that those views were made known to inspectors and that we should no longer expect them to take the view that a company that does not apply for clearance is necessarily hiding something. That said, for the avoidance of doubt, we would always advise clients to apply for clearance for all transactions for which a clearance is available. In our view, certainty of tax treatment for our clients is more important than the administrative convenience of HMRC’s BAI Clearance Team.

1 By Chris Tailby, then Head of HMRC’s Anti-Avoidance Group, which included the Clearance and Counteraction Team, in a talk in June 2006.

TCGA 1992, s 138(2) – form of clearance application 14.7 ‘(2) Any application under subsection (1) above shall be in writing and shall contain particulars of the operations that are to be effected and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subsection, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.’ 311

14.8 Clearances Analysis1 14.8 This provision tells us the form of the application for clearance. The application must be in writing and must give full details of the transactions to be carried out. Applications for clearance under any of the relevant statutory provisions should be sent to:2 BAI Clearance HMRC BX9 1JL ‘In writing’ includes e-mail to [email protected] but there is no longer any reference to applications by fax. HMRC has also said that they do not want such applications backed up in hard copy as the system will just treat them as separate applications wasting everybody’s time. All email applications should contain the following wording, to ensure that HMRC can also reply by emails: ‘I confirm that our client understands and accepts the risks associated with email and that they are happy for you to send information concerning their business or personal details to us by email. I also confirm that HMRC can send emails to the following address (or addresses) …’ Applications by email are acknowledged automatically, usually within a few minutes of sending. The website no longer gives specific advice for market-sensitive transactions. It simply refers to the need to consider whether email is a suitably secure way to apply for clearance. So, for applications that contain information that could affect the price of a stock market-quoted company or information concerning the financial affairs of well-known individuals, it might be better to rely on the postal system. Only a single letter is required where taxpayers are asking for clearance under more than one of the available clearance provisions. If the officer considering the application requires more information, she may request that information within 30 days of receiving the original clearance application. If that information is not received within 30 days (or longer if the Board allows), the application is deemed to lapse. In practice, we have never seen an application treated as having lapsed just because a taxpayer took too long to supply the information, so long as it is supplied eventually. After all, if it takes more than 30 days to supply the further information, the applicant 312

Clearances 14.10 can simply make a completely new application, including the further facts requested by the officer. It is notable that taxpayers are required to give details of the transactions (or ‘operations’ as the legislation refers to them), but not specifically of the bona fide commercial reasons for the transaction and not details of evidence that there is no tax avoidance motive. Of course, it is a matter of common sense that these details be supplied too. There is a great deal of helpful information available from the HMRC website about clearances, at www.gov.uk/guidance/seeking-clearance-orapproval-for-a-transaction. This is a jumping off page for a number of areas where advice and clearances may be available, including a variety of other statutory clearances, non-statutory clearances and the general anti-abuse rule (‘GAAR’). Statement of Practice 13 of 1980 (SP13/80) is strictly about demerger clearances under CTA 2010, ss 1091 and 1092 (see Chapter 24), but it has some helpful information about the form and information required in any clearance application. This can be found at www.gov.uk/government/publications/ statement-of-practice-13-1980/statement-of-practice-13-1980. We would always recommend that practitioners and taxpayers read the guidance carefully whenever they are making an application for clearance under any of the statutory provisions.

1 The authors would like to acknowledge that much of this information has been taken directly from the government website. 2 The actual title and address changes from time to time, so applicants should check the website before proceeding.

TCGA 1992, s 138(3) – obligation of the Board 14.9 ‘(3) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subsection (2) above, within 30 days of the notice being complied with.’ Analysis 14.10 This is a simple time limit for the inspectors in the BAI Clearance Team. They must give a substantive response, either a decision or a request for further information, within 30 days of receiving the application. The only 313

14.11 Clearances sanction, however, for a failure in this obligation is for the applicant to refer the decision to the First-tier Tribunal (see TCGA 1992, s 138(4) below).1

1 Despite the best efforts of opposition MPs during the 1977 Finance Bill debates. They argued strongly for the legislation to be amended so that if no response to an application was received within 30 days, the Board was deemed to be satisfied that the transaction did not fall foul of TCGA 1992, s 137(1).

TCGA 1992, s 138(4) – appeal against the decision of the Board 14.11 ‘(4) If the Board notify the applicant that they are not satisfied as mentioned in subsection (1) above or do not notify their decision to the applicant within the time required by subsection (3) above, the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subsection (2) above, to the tribunal; and in that event any notification by the tribunal shall have effect for the purposes of subsection (1) above as if it were a notification by the Board.’ Analysis 14.12 First, although TCGA 1992, s 138 does not require HMRC to explain why an application for clearance has been denied, as a matter of practice, an applicant is always informed as to the area(s) of concern. This allows taxpayers to correspond with HMRC if clearance has been denied in order to see if HMRC’s concerns can be allayed. In practice, HMRC is usually willing to consider further comment or to opine on changes to the structure with a view to being able to grant clearance. Remember, however, as always, that HMRC’s latitude is limited and also that their ability to respond swiftly is likely to depend upon how busy the inspectors are. As noted above, should the Board refuse to grant a clearance (or in the event of a failure to comply with the time limit in TCGA 1992, s 138(3)), the applicant may appeal to the First-tier Tribunal. The time limit is 30 days from the expiry of the original (or subsequent) 30-day time limit or, in the case of a refusal, 30 days from the date of the refusal. A decision by the Tribunal will be treated as if it were a notification by the Board of HMRC. More importantly, the Tribunal’s decision is final and a clearance by the Tribunal therefore overrides the Board’s refusal. Readers may be a little circumspect about an appeal to the Tribunal. However, this is a very simple and straightforward process and, important to many taxpayers and practitioners, the process does not require a personal hearing 314

Clearances 14.14 in front of the Tribunal, it is all done by correspondence. The legislation says that the Board must ‘transmit’ the application letter and other information to the Tribunal, who will then consider it and make a decision. In practice, the applicant will usually accompany the request for review by the Tribunal with a detailed explanation as to why the applicant considers the Board’s refusal to be incorrect. The inspector will then forward this, with all the other correspondence, to the Clerk to the First-tier Tribunal, with a detailed exposition of HMRC’s reasons for refusal. In the authors’ experience, this is also copied to the applicant. The Tribunal’s decision usually comes through in three to five weeks or so and is sent to both HMRC and the applicant. Overall, this is not a daunting process and its use should be considered more often in borderline cases. It is interesting to note that, although the overall theme of TCGA 1992, s 138 was borrowed from the transactions in securities legislation, those provisions have no equivalent right of appeal against any refusal of clearance by the Board. TCGA 1992, s 138(5) – voiding of decisions 14.13 ‘(5) If any particulars furnished under this section do not fully and accurately disclose all facts and considerations material for the decision of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subsection (1) above shall be void.’ Analysis 14.14 This is an extremely important provision. Should an application later be found not to have fully disclosed all the relevant facts, the clearance can be voided. The importance of this was highlighted in the Special Commissioner’s decision in Harding v HMRC SpC 608. The Special Commissioner found against Mr Harding on a number of technical grounds (see Chapter 9). But he also noted that Mr Harding had applied for clearance under TCGA 1992, s 138 and that the clearance had been granted by HMRC. On inspection, the Special Commissioner noted that the clearance application had failed to mention the important aspects of the bond that made it apparently attractive for tax planning purposes (that it was designed to be a non-QCB when it was issued but to be a QCB when it was redeemed). As the Special Commissioner said, the ‘letter to the Revenue was, to be charitable, wholly inadequate for its purpose’. Since TCGA 1992, s 138(5) provides that inadequate disclosure makes any clearance void, HMRC was entitled to reconsider whether the original sale 315

14.15 Clearances transaction and receipt of the bond had been ‘effected for bona fide commercial reasons and [did] not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to capital gains tax’. Under the circumstances, HMRC may have found that the transaction was undertaken for bona fide commercial reasons (as in the Snell case, Chapter 13) but it also seems likely that they would have taken the view that it formed part of a scheme or arrangements of which the main purpose, or one of the main purposes, was avoidance of liability to capital gains tax. In the event, HMRC did not pursue the validity of the clearance. But this case emphasises that it is vital to give HMRC all relevant information when applying for a clearance, otherwise that clearance is void. At least if a clearance is refused, a transaction can be restructured to try and achieve a better result. But a transaction that has been carried out under an invalid clearance is irrevocable.

PRACTICAL ISSUES Chasing applications 14.15 The website no longer gives a telephone number for enquiring about the progress of an application or making general enquiries.

Timing of applications 14.16 Given the 30-day timescale in TCGA 1992, s 138, it is important to consider clearance applications earlier rather than later to ensure that there is plenty of time to obtain clearance for a transaction before it is carried out. It is also important because it is not possible to rely on HMRC being willing to expedite a clearance for an imminent transaction, particularly at busy times when there are other clearance applications that may be getting close to the 30-day deadline. As a practical point, it is vital that the initial clearance application is complete in all material respects in order to avoid HMRC asking for further information, thus restarting the 30-day clock. Equally important is clarity in the clearance application. In the authors’ experience, the best letters are those that tell the story clearly, concisely and logically, so the inspector has all the information required to grant a clearance without further ado. A badly written letter invites queries and therefore creates delay. While clearance applications should be comprehensive, it is frequently the case that the final details are not decided until relatively late in the process. 316

Clearances 14.17 In such a case, it is preferable, in the authors’ experience, to make a clearance application earlier rather than later, also making a point of detailing the area(s) where decisions are yet to be finalised, together with the likely outcome. If the final decisions are materially different from what was originally advised to HMRC, a supplementary letter will be required to get final sign-off. Strictly, such a letter is a new application for clearance, but in circumstances like this the inspector will usually expedite the clearance on the basis that there are only minor differences to consider.

Urgent applications 14.17 If your application is urgent, it makes sense to say so in the title of the letter or e-mail applying for clearance. When clearance applications are initially received, they are allocated a reference number and passed to an inspector. If the statement that the application is urgent is at the end of the letter or hidden in the explanatory text, no one will be aware of the urgency until the inspector reads the letter in detail. When one of us1 had a clearance role, we always advised taxpayers to state at the very top of the letter if it was commercially urgent. The letter should then explain the commercial urgency, to justify asking HMRC to prioritise the application. In our past experience, BAI Clearance has always done its very best to comply with reasonable requests for urgent clearances. However, since a wholesale replacement of the clearance team members during 2019 and early 2020, this no longer appears to be the case, and no special priority is being given to urgent cases at the time of writing. In any case, it is also important to be aware of the other pressures on officers to process all applications within the 30-day time limit, particularly at busy times. So make sure your application really is urgent before taking this approach. If taxpayers or practitioners constantly demand quick turn-around times on what are essentially non-urgent cases, this is likely to be to the detriment of their relationship with BAI Clearance. This could make life very difficult for an adviser who regularly applies for clearance on behalf of clients. Also, remember that HMRC’s officers are human too! There is nothing more annoying than being begged for an urgent clearance when it is clear that the transaction had been under consideration for some considerable time and the clearance application could and should have been made much earlier in the process.

1 PM.

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14.18 Clearances

OTHER TAX REGIMES 14.18 It is worth mentioning here that the increase in the number of regimes for taxing different kinds of asset has meant a commensurate increase in the range of transactions for which clearances are available. Most of the procedural points discussed in this chapter will be relevant to those other clearances, too. This most obviously applies to clearances under the regime for intangible assets (in CTA 2009, Part 8, ss 831–833). However, we have recently been made aware that these clearances are dealt with by the technical team that looks after this legislation, and not by BAI Clearance themselves. This has the effect of slowing down those clearance applications, as they are no longer dealt with by a ‘one-stop shop’, and can also lead to other issues, such as about which company should make the application (see 18.42).

CONCLUSION 14.19 These provisions are another example of the adaptation of a piece of tax legislation to a new purpose. In this case, we have the clearance provisions from the Transactions in Securities legislation being adapted to the anti-avoidance requirements of the rules deeming certain transactions to be reorganisations. The main provisions were lifted directly from the transactions in securities legislation, although a facility to appeal to the First-tier Tribunal has been added to the capital gains legislation. This is also an area where HMRC is keen to show itself as customer focused, as might be inferred from the wealth of useful information available on the HMRC website. In earlier editions of this book, we were able to assert that BAI Clearance and its predecessors invariably ensured that the clearances were dealt with in time and, in cases of technical difficulty or commercial complexity, frequently made themselves available for telephone calls (and occasionally meetings) in order to help to resolve matters where possible, contrary to the fears of MPs in 1977 that civil servants were not able to make decisions about commerciality. Sadly, since the appointment of the new team, this is no longer the case. Not only is the team impossible to contact other than by email but some of their decisions are incomprehensible in the light of the legislation and decided cases, as well as being inconsistent with clearances granted readily over the previous 25 years of our experience.

STAMP TAXES 14.20 There are no specific provisions for obtaining stamp tax clearances in advance of the transaction. However, as explained in Chapter 2, if clearances 318

Clearances 14.21 are obtained in respect of other taxes, HMRC regard this as conclusive proof that there is no avoidance motive in deciding whether the stamp duty reliefs under FA 1986, s 75 may be claimed. However an additional anti-avoidance provision in FA 1986, s 77A means that, from 29 June 2016, it is also necessary to satisfy HMRC that there are no ‘change of control’ arrangements in order to qualify for relief under FA 1986, s 77.

VALUE ADDED TAX 14.21 Professional fees, accountants’ or lawyers’ fees, will be incurred in connection with the clearance application and (if it is refused) debating it with HMRC after a refusal. These costs may be incurred by the Sellers, Target or the Buyer. These will be costs of the intended exercise and the extent to which the party is entitled to a refund of the input VAT follows the principles explained in the chapter dealing with the type of reconstruction in question. The fact that, in a share exchange case, for example, the Sellers cannot technically make a clearance application themselves (see 14.3) can be a help. It means that Target is justified in incurring the costs of making the application, and if Target is carrying on a fully or partially taxable business it will be entitled on general principles to a refund of all or part of the input VAT, whereas the Sellers might in a typical case not be entitled to any refund. In a case where the costs of the clearance application may be significant, it should be arranged that Target enters into an engagement with the professionals, separate from the Sellers’ engagement with them, to draw up the clearance application, and the professionals should bill Target for this work.

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Part 4

Reconstructions

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Chapter 15

Introduction to reconstructions

INTRODUCTION 15.1 In Part 4, we cover corporate ‘reconstructions’. First, we are going to look at the history of the word ‘reconstruction’ in the context of corporate and tax law. This led to the development of a specific tax definition of a reconstruction surprisingly recently. Then we will look at specific reliefs from taxation of chargeable gains that depend on a reconstruction being present. Finally, we will review some transactions to which these provisions might apply. We then go on to look at particular types of reconstruction, particularly mergers and demergers, as well as at the specific provisions relating to cross-border reconstructions.

MEANING OF ‘RECONSTRUCTION’ – THE PLAIN ENGLISH APPROACH 15.2 The first point to note is that the phrase more usually encountered is ‘scheme of reconstruction’, as in the title of TCGA 1992, Sch 5AA: Meaning of ‘Scheme of Reconstruction’ and in TCGA 1992, ss 136 and 139. For most of the history of corporate and tax law there was no technical definition of ‘reconstruction’, so we should start by looking at the plain English meaning of the word. The 1993 edition of the New Shorter Oxford Dictionary gives us a late eighteenth-century definition: ‘the action or process of reconstructing, rebuilding or reorganising something’. The definition of ‘reconstruct’ is to ‘construct, build, form, or put together again’ (authors’ italics). It is this latter phrase that comes closest to the meaning that might be most appropriate for company reconstructions, the putting together again of the company or its business. However, this is not sufficient for the detailed technical purposes of company or tax law and, as we shall see, a plain English approach was rejected by the courts.

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15.3 Introduction to reconstructions

COMPANY LAW DECISIONS 15.3 We turn next to company law cases where the meaning has been considered. In this context, it is interesting that the New Shorter Oxford Dictionary also has a late nineteenth-century definition of ‘reconstruction’ as ‘the reorganisation of a public company by closing down operations and disbanding personnel, followed by immediate reformation as a new company under similar ownership, in order to redistribute capital, resources, etc’. It may well be that this was in the mind of the judges considering the seminal cases in this area, although it is equally likely that the court decisions as to the meaning of ‘reconstruction’ in a commercial context have informed the dictionary entry. The first case we will look at is Hooper v Western Counties and South Wales Telephone Co Ltd (1892) 68 LT 78. The Western Counties and South Wales Telephone Co had issued debentures in 18891. The company was entitled to redeem them at its discretion, at a 5 per cent premium plus interest to the date of redemption. If the company were wound up, the principal was repayable to debenture holders unless the winding up was for ‘the purpose of reorganisation or reconstruction’. The company agreed to sell most of its assets to a competitor, the National Telephone Co. The only assets being retained were the operating licence and some cash. The consideration was to be the issue of shares and debentures by the National Telephone Co to the shareholders and debenture holders of Western Counties and South Wales Telephone Co. That company was then to be wound up (see Figure 15.1). Figure 15.1 Hooper v Western Counties & South Wales Telephone Co

One of the debenture holders contended that the winding up was for the purpose of reorganisation or reconstruction and that the company was not, therefore, entitled to redeem the debentures unless it also paid the 5% redemption premium. Chitty J said that the words ‘“reorganisation or reconstruction” … are not words of art. They have no technical meaning in law’. He then decided against using a plain English meaning, with these words: ‘That would be a dangerous course for the court to follow. I take it that an ordinarily prudent member of the public would, if he were also 324

Introduction to reconstructions 15.3 ordinarily modest, hesitate before putting a meaning to these words. The better course is to refer to persons acquainted with the subject’. So there is no further merit in the dictionary definitions referred to above. Chitty J decided that the better course in this arcane field was to refer to experts on company law. The experts’ view of a reconstruction was that it was a transaction whereby a company resolves to wind itself up and transfers all its assets to a new company. The new company then issues shares to the shareholders of the old company. As a result, although the old company ceases to exist, the new company is ‘practically the same’2 as the old company, having the same business and the same shareholders (albeit perhaps having a different constitution). Furthermore, the transaction in this case was an amalgamation and the experts agreed that an amalgamation was not a reconstruction. Therefore, the transaction could not be a reconstruction. It is also of interest that Chitty J found the words ‘reorganisation’ and ‘reconstruction’ to be alternative terms, ie meaning the same thing, which is clearly not the case for modern-day tax purposes. To summarise the position after Hooper v Western Counties and South Wales Telephone Co Ltd, the view was that a reconstruction required the new company to have exactly the same shareholders and exactly the same business as the old company (although this seems slightly more onerous than Chitty J’s words suggest in his judgment). However, this view was overturned 10 years later in the case of Re South African Supply and Cold Storage Co [1904] 2 Ch 268. Figure 15.2(a)

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15.3 Introduction to reconstructions South African Supply and Cold Storage Co (‘SACo’) was formed in 1899 and issued 150,000 £1 cumulative preference shares that were redeemable at a 15 per cent premium if the company were to be wound up for the purpose of reconstruction or amalgamation. SACo also issued £1 million debenture stock that was redeemable at a premium of 7.5 per cent if the company were to be wound up for the purpose of reconstruction or amalgamation. In 1902 SACo sold its business, comprising less than half its assets (£1 million assets were sold and the assets retained were valued at £1.5 million), to a new company set up for the purpose, the South African and Australasian Supply and Cold Storage Co (‘AusCo’). The purchase price was settled partly by cash and partly in return for an issue of shares and debentures by AusCo to SACo, so that AusCo became a subsidiary of SACo (see Figure 15.2(a)). Later, Cold Storage Trust (‘CST’) was set up and all the AusCo shares and the other assets of SACo were transferred to CST in return for an issue of shares and debentures. There was subsequently an amalgamation transaction whereby AusCo sold all the assets it had just acquired from SACo, along with working capital, to a competitor, the Imperial Cold Storage and Supply Co (‘Imperial’). The consideration was wholly in return for the issue of shares and debentures by Imperial to AusCo (see Figure 15.2(b)). Both SACo and AusCo were then liquidated, so their assets passed to the shareholders of SACo (see Figure 15.2(c)). AusCo had issued preference shares and debentures with conditions identical to those issued by SACo. An action was brought by a debenture holder of SACo demanding redemption with the 7.5 per cent premium on the basis that the transaction was a reconstruction and the winding up was for the purpose of that scheme. The case was joined with the liquidator who needed to know whether the preference shares had to be redeemed with the 15 per cent premium too. The main question for the court was whether the transaction was a reconstruction, given the limited scope of the meaning of that phrase following the Western Counties and South Wales Telephone Co case. Buckley J noted that the word ‘reconstruction’ does not have any definite legal meaning. Instead, he said that it is a commercial term, but ‘even

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Introduction to reconstructions 15.3 as a commercial term, bears no exact definite meaning’. In his view, a reconstruction required that ‘substantially the same business shall be carried on and substantially the same persons shall carry it on’. In contrast to Chitty J’s earlier view in the Western Counties and South Wales Telephone Co case, ‘it does not involve that all assets shall pass to the new company … or that all the shareholders of the old company shall be shareholders in the new company’. The subsidiary question was whether the winding up was carried out for the purpose of reconstruction. Buckley J quickly concluded from a review of the various documents that this was the only possible purpose of the winding-up order. Figure 15.2(b)

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15.4 Introduction to reconstructions Figure 15.2(c)

In summary, following the South African Supply case, to be a reconstruction, the identities of the shareholders and of the business do not need to be exact. Buckley J made it clear that the identity needs to be substantial rather than absolute, ie substantially the same trade, not exactly the same trade, had to be carried on by substantially the same body of people, rather than exactly the same body of people. Although the Western Counties and South Wales Telephone Co case was referred to in arguments, Buckley J himself does not refer to it in his judgment and therefore does not explain the divergence of his view from that of Chitty J.

1 The rubric to the case report says 1896 but this must be a misprint. The text of the case refers to the debentures being issued in 1889. 2 Chitty J was here quoting Lindley LJ in his book Law of Companies (5th edn), p 900.

EARLY TAX LEGISLATION 15.4 Before moving into tax matters, it is important to put these company law cases into their proper perspective. The cases we have discussed above relate only to the question of whether certain transactions were ‘reconstructions’ for commercial purposes. In essence, did the shareholders or bondholders have essentially (or substantially) the same assets and rights after the transactions as before? If so, there had been a reconstruction; if not, there had been some other transaction such as an amalgamation or disposal. 328

Introduction to reconstructions 15.4 When we come to look at tax legislation and decided tax cases, the question being asked is rather different. Now, the issue is whether the transaction that has been carried out is a transaction that Parliament intended should be within the charge to tax or within the scope of specific exemptions. The history of the legislation shows clearly that Parliament did not intend reconstructions to be within the charge to tax, which is why there were, for example, exemptions from stamp duty for some of these transactions (as in the Brooklands Selangor Holdings case discussed below) from at least 1927 and from the taxes on capital gains when they were introduced in 1962 and 1965. The reason for the policy decision may well have been because transactions of reorganisation or reconstruction left shareholders in practically or substantially the same position as before (and, of course, with no cash bounty from the transactions with which to pay any tax bill). Alternatively, it may be that Parliament realised the commercial importance of transactions such as reorganisations and reconstructions and did not want to discourage such transactions by imposing an onerous tax burden. This latter approach is a more likely explanation for the exemptions relating to amalgamations and even partitions which are, by their very nature, forms of disposal. As a result, we have the equation of reconstructions and amalgamations in FA 1962, Sch 9, para 13(3) (see below). This equation is still in the legislation today, albeit in rather different form, in TCGA 1992, Sch 5AA, which says that ‘“scheme of reconstruction” means a scheme of merger, division or other restructuring …’. Whatever the reasons, it was decided that certain transactions should be exempt from the new taxes on capital gains. Some of these transactions were already exempt from stamp duty and the policy reasons for both exemptions may have been similar. To comply with this policy, there were exemptions for various transactions for company reconstructions and amalgamations. The exemption for share exchanges, the precursor to what is now TCGA 1992, s 135, was discussed in Chapter 8, but there are two further exemptions to discuss here, both of which are still recognisable in current legislation, albeit in substantially modified form. These relate to ‘schemes of reconstruction or amalgamation’, a phrase that was also found in the company law cases discussed above. The transactions covered are clearly described by the words of the legislation enacted in 1962 charging short-term gains to income tax under Case VII of Schedule D. FA 1962, Sch 9, para 13 reads, so far as relevant to this discussion, as follows: ‘(1) Where under any arrangement between a company and the persons holding shares or debentures of the company or any class of such shares or debentures being an arrangement entered into for the purposes of or in connection with a scheme of reconstruction or amalgamation, another company issues shares or debentures to those persons in respect of and in proportion to (or as nearly as may be in proportion to) their holdings of 329

15.4 Introduction to reconstructions the first-mentioned shares or debentures, but the first-mentioned shares or debentures are either retained by those persons or cancelled, then those persons shall be treated as exchanging the first-mentioned shares or debentures for those held by them in consequence of the arrangement1 (any shares or debentures retained being for this purpose regarded as if they had been cancelled and replaced by a new issue). (2) Where any scheme of reconstruction or amalgamation involves the transfer of the whole or part of a company’s business to another company, and the first-mentioned company receives no part of the consideration for the transfer (otherwise than by the other company taking over the whole or part of the liabilities of the business), then the first-mentioned company shall not be chargeable under Case VII by reference to the transfer in respect of its acquisition and disposal of any assets included in the transfer. (3) In this paragraph ‘scheme of reconstruction or amalgamation’ means a scheme for the reconstruction of any company or companies or the amalgamation of two or more companies …2’ The first thing to strike us is that, more than 50 years on, FA 1962, Sch 9, para 13(1) and (2) are still with us in recognisable form as TCGA 1992, ss 136 and 139! The legislation was (and still is) intended to give relief at two levels. First, where a scheme of reconstruction or amalgamation involves shareholders of one company being issued shares by another company, in respect of the first holding, there was no tax on any apparent or actual disposal of the original shareholding. That is the shareholder relief. Secondly, there is a relief for the company that transfers its assets to another company for no consideration as part of a scheme of reconstruction or amalgamation. Without this exemption, there would have been a charge as if the disposal had been at market value (by what are now TCGA 1992, ss 17 and 18), but the exemption ensured that there was no capital gains tax on the disposal, a relief at company level. The relief is given slightly differently under modern legislation – see TCGA 1992, s 139 below – but the principle remains the same that the reconstruction is not intended to be a taxable event. Let us look at these provisions in the context of the corporate transactions concerned. For example, in the first transaction in the South African Supply case, the reconstruction of SACo into AusCo, the business of SACo was transferred to AusCo in return for an issue of shares and debentures to SACo itself. Would these transactions have been exempt from income tax under the 1962 legislation?

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Introduction to reconstructions 15.4 Looking at the individual steps, they may not have been. We see that SACo receives consideration for the transfer of assets to AusCo, being an issue of CST shares to SACo, so FA 1962, Sch 9, para 13(2) does not apply, as the transaction was not for no consideration. And, since the AusCo shares were issued to SACo and not to its shareholders, FA 1962, Sch 9, para 13(1) is not in point, either. Similarly, if we analyse the transfer of the business on to Imperial, AusCo, not its shareholder (SACo) received the consideration, so FA 1962, Sch 9, para 13(1) and (2) would not have been in point. However, we get a different result if we look at the transactions as a whole (Figure 15.2(c)). After the winding up of SACo and AusCo, the ex-shareholders of SACo hold shares in CST and Imperial and CST and Imperial between them hold all the assets of SACo. Furthermore, any consideration given for the transfer of the business and other assets has been passed to the ex-shareholders of SACo. So, looking at the scheme in the round, we could argue that there was a scheme of reconstruction or amalgamation, in line with the decisions in the case, although the transactions actually carried out do not fit easily into the analysis. On that basis, looking at the transactions as a whole, we can see how the exemptions at FA 1962, Sch 9, para 13(1) and (2) might have been intended to apply to transactions that achieve this result. What we are seeing, of course, is the 1962 tax statute reflecting the types of corporate transactions of reconstruction (or amalgamation) as they are carried out in 1962 (under CA 1948), not as they were carried out in 1902 (under CA 1862). By 1962, the more usual transaction for company or business amalgamations was to elide the steps that were carried out in the South African Supply case, ie company A would transfer its business to company B and company B would issue shares (or debentures) to the shareholders of company A pro rata to their holdings in company A (see Figure 15.3). Figure 15.3 Scheme of reconstruction or amalgamation

It was not prima facie necessary to wind up company A as the shares issued by company B are already in the hands of company A’s shareholders. So this form of transaction could be used for simple business separations (demergers) too where company A transfers only part of its business to company B (see Figure 15.4). Demergers are considered in more detail later. 331

15.4 Introduction to reconstructions Figure 15.4 Demerger

In 1965, a full-scale capital gains tax was introduced and the income tax charge on short-term gains was abolished when the new tax was implemented. However, the exemptions for schemes of reconstruction or amalgamation were substantially the same. The shareholder relief at FA 1965, Sch 7, para 7(1) was identical to its predecessor, FA 1962, Sch 9, para 13(1). The company-level relief at FA 1965, Sch 7, para 7(2) was very similar to FA 1962, Sch 9, para 13(2). However, rather than merely exempting the transfer from charge, the 1965 legislation treated the transfer as being at such a consideration that no gain and no loss would arise to the transferor company, which is still the case in the modern legislation in TCGA 1992, s 136. This difference would have been necessary to reflect the fact that the 1962 legislation was a tax on short-term gains applying only where assets were held for less than six months, but the 1965 capital gains tax was a tax on all gains, not just those that arose in the short term, so a mechanism was required to ensure that tax could be charged on the eventual non-exempt disposal of the assets transferred in the reconstruction or amalgamation. The definition of a ‘scheme of reconstruction or amalgamation’ at FA 1965, Sch 7, para 7(3) was also identical to its predecessor, FA 1962, Sch 9, para 13(3). In the historical context, what we are seeing is the implementation of tax policy to align the fiscal requirements of the scheme for taxation of capital gains with the real-world transactions that are carried out by businessmen and women every day. Much of the history of tax legislation follows this pattern with tax law and practice evolving with changing business practices. As we shall see, FA 1965 was by no means the end of the story.

1 Effectively invoking FA 1962, Sch 9, para 12, which is more or less the same as the current TCGA 1992, s 135. 2 It is an interesting quirk of the parliamentary process that FA 1962, Sch 9, para 13 was inserted at committee stage as a government amendment. Clearly, the consequences of company reconstructions and amalgamations had not been considered properly by the policy makers when they put together the new tax on capital gains. A clear failure to consult properly with industry, perhaps?

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Introduction to reconstructions 15.5

WHAT IS A RECONSTRUCTION? 15.5 Readers will have noticed that the legislation in 1962 and 1965 did not actually tell us what a reconstruction is. The so-called ‘definition’ merely said that a reconstruction included reconstructions of any one or more companies (in effect) and told us the consequences if there was a scheme of reconstruction or amalgamation, but it is not always clear that the transaction in point is itself a reconstruction. Following the South African Supply case, we apparently had a working definition of a reconstruction, which was at least considered adequate for the operation of the legislation introduced in 1962. Specifically, we have Buckley J’s dictum that a reconstruction requires that ‘substantially the same business shall be carried on and substantially the same persons shall carry it on’. The corporate mechanisms for reconstruction may have changed over the 60 years since that decision, but that was still the most up-to-date definition available for a reconstruction. The case of Brooklands Selangor Holdings Ltd v IRC [1970] 2 All ER 76 demonstrated the inadequacy of this definition as company law and practice developed. Hitherto, the transactions we have considered were for the reconstruction of a company by transferring its trade to a new company or amalgamation by transfer of the trade to another active company, but a new type of transaction was developing, the business separation or ‘demerger’, and the South African Supply definition of reconstruction proved sadly inadequate. Brooklands Selangor Rubber Co Ltd (‘BSR’) had a corporate shareholder, Plantation Holdings Ltd (‘PH’), that held the majority of the shares (72 per cent of the preference stock and over 50 per cent of the ordinary shares). The minority shareholders differed with PH as to the way in which BSR should operate and an agreement was reached whereby BSR’s assets would be partitioned between the shareholder groups. The transactions proceeded with BSR incorporating a subsidiary, Brooklands Selangor Holdings Ltd (‘Holdings’), with minimal share capital. Appropriate assets were then transferred to Holdings from BSR. The consideration was just over 10 per cent in cash and the rest by an issue of shares by Holdings directly to the minority shareholders of BSR. As a result, Holdings became effectively owned by the original minority shareholders of BSR (see Figure 15.5).1

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15.5 Introduction to reconstructions Figure 15.5 Brooklands Selangor Holdings Ltd v IRC

The reason for the case was the application of UK stamp duty to the transfer of part of BSR’s business to Holdings. Holdings claimed relief under the stamp duty relief for reconstructions available (then) under FA 1930, s 552. The question for the court, therefore, was whether the transactions carried out amounted to a reconstruction3. In this context, Pennycuick J referred to only two previous decisions, Hooper v Western Counties and South Wales Telephone Co Ltd and Re South African Supply and Cold Storage Co, and he adopted Buckley’s definition whereby ‘substantially the business and the persons interested must be the same’ as the correct definition of ‘reconstruction’. In reviewing the transactions involving BSR and Holdings, he noted that the shareholders of Holdings, while the vast majority in number, had owned only about half by value of the shareholdings of BSR and the transaction related to only part of the undertakings carried on by BSR. In Pennycuick J’s words: ‘That, I think, involves a substantial alteration in the membership of the two companies within the meaning of the passages I have quoted from the judgments of Chitty and Buckley JJ. It seems to me that that transaction is not a reconstruction and that a transfer made pursuant to that transaction falls neither within the letter nor within the intent of section 55’. Overall, therefore, the decision was that this transaction did not constitute a scheme of reconstruction and the appropriate stamp duty relief was not applicable. This established the principle that certain forms of reconstruction, ie business partitions as in the Brooklands Selangor case, were not reconstructions as a matter of law and could not be taxed (or exempted from tax) as if they were reconstructions.

1 The case stated shows that the original intention was for some of the BSR shares, presumably those held by minority shareholders, to be cancelled and the subscriber shares in Holdings to be transferred to the minority

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Introduction to reconstructions 15.6 shareholders. It is not clear if these steps were actually carried out, but even so there was only £100 of subscriber share capital and over £1 million of shares issued to the minority shareholders. 2 Now FA 1986, s 75. 3 There were other questions for the court that were not relevant to this discussion.

NON-STATUTORY TAX PRACTICES 15.6 As transactions involving business partitions became more common, this situation was clearly unacceptable. Parliament (presumably) intended that capital gains relief be available for such demerger or partition transactions as if they were schemes of reconstruction. As a result, the Inland Revenue issued a press release on 16 October 1975 (frequently referred to as ‘Statement D14’) granting ‘reconstruction treatment’ for certain business partitions which otherwise failed the South African Supply test, as demonstrated by the Selangor Holdings case. This became the well-known (to those of us of a certain age!) Statement of Practice 5 of 1985 (‘SP 5/85’) under which many demergers were to be treated as schemes of reconstruction. The assumption here is that Parliament (or the Revenue) was reluctant to legislate a definition of ‘reconstruction’ possibly because there were so many types of transaction to which the word ‘reconstruction’ might apply that it would be inordinately difficult to come up with a definition that managed to include all transactions that are reconstructions, while excluding all those that are not. (It is also noteworthy that this was a period when the Revenue was seemingly content to tax by legislation, then un-tax by concession and practice. As a result, the 1970s and 1980s saw a burgeoning of Extra-Statutory Concessions and Statements of Practice.) It is interesting to speculate as to why the Inland Revenue decided, presumably sometime between 1970 (when Brooklands Selangor was decided) and 1975 (when the press release was issued), that the relief from tax on capital gains for reconstructions should apply to these transactions, but that the relief from stamp duty for reconstructions should not apply. The distinction remains even today, so that the tax analyses for a demerger require us to look at the specific definition of a scheme of reconstruction for capital gains tax and corporation tax, on one hand, and the company law definitions for the purposes of stamp duty and stamp duty land tax, on the other. The case of Morgans Executors v Fellows 74 TC 232 demonstrated the dangers of exemption from tax by concessionary practice rather than by properly considered legislation. In this case, Fox & Morgan Ltd (‘F&M’) carried on two main activities, referred to as ‘the locks division’ and ‘the pressings division’. In 1979, a decision was taken that the business of each division should be carried on by separate companies owned by separate groups of shareholders. The mechanism (described in more detail in Chapter 23) required F&M to 335

15.6 Introduction to reconstructions be liquidated and the locks and pressings divisions to be transferred to new companies: ‘Locks’, largely owned by Norman Morgan and his wife, and ‘Pressings’, mainly owned by Barrie Morgan and his wife (see Figure 15.6). Figure 15.6

This was described by Park J as ‘a classic subject matter for a press release reconstruction’. An application for clearance was made in respect of the transaction (under what is now TCGA 1992, s 138). Under the practice at that time, i.e. under Statement D14 – the 1975 press release – the clearance was granted with the proviso that the acceptance of the partition transaction as a scheme of reconstruction or amalgamation involved ‘an element of concession’. However, this concessionary treatment was granted under Statement D14 so long as both of the transferee companies, Locks and Pressings, gave an undertaking that the tax consequences of this treatment would apply to those companies. What this meant was that F&M would be treated as transferring the assets of the locks and pressings divisions to the appropriate transferee companies at a consideration such that there was no gain and no loss as if the transaction were a scheme of reconstruction to which FA 1965, Sch 7, para 7(2) applied, but this concession would only be granted if those transferee companies gave the Inland Revenue written undertakings that the tax treatment of any future disposal of those assets would also follow this concessionary approach, so that any gains would be computed as if the base cost of the assets was the deemed consideration on the transfer from F&M. Otherwise, the strict statutory result would be that Locks and Pressings would each be able to claim that the base cost of the assets was the market value of those assets in 1980 when they were transferred. At the shareholder level, the concessionary treatment as a scheme of reconstruction under FA 1965, Sch 7, para 7(1) meant that the shareholders were treated as having exchanged their shares in F&M for shares in Locks or Pressings. This meant that they were treated as not having made any disposal of the original F&M shares and the new holdings of shares in Locks or Pressings 336

Introduction to reconstructions 15.6 were treated as having the same original base cost as the original F&M shares. However, the clearance granted by the Inland Revenue did not require any written undertakings from the shareholders as to the treatment of any future disposals of their shareholdings in the successor companies. In 1987, Norman Morgan sold shares in Locks and was assessed to capital gains tax. The gain was computed as if the base cost of his Locks shares was the original base cost of his shares in F&M, but Norman’s executors (Norman died in 1994) argued that the 1980 transaction was not a scheme of reconstruction, following the South African Supply and Brooklands Selangor Holdings cases. Therefore, the base cost for the computation of the gain must be the market value of the Locks shares when they were issued in 1980 and the gain assessable on Norman’s estate was commensurately smaller. While Norman had been permitted to take advantage of the concessionary treatment under Statement D14 in 1980, his executors were under no obligation to abide by that treatment in respect of the disposal in 1987. Clearly, also, the Revenue was forced to argue in this case that a scheme that was agreed in 1979 – when clearance was granted – not to be a scheme of reconstruction was, in fact, a scheme of reconstruction (and hence, arguably, that Statement D14 and SP 5/85 had been redundant all along)! Park J’s decision was very straightforward: the transaction was not, as a matter of law, a reconstruction. While it was considered beneficial to taxpayers as a whole that the Inland Revenue treated such transactions as reconstructions, it was clearly the case that there was no contractual obligation on Norman (or his executors) to accept a reduced base cost in his shares in Locks and, therefore, the Inland Revenue lost the case. Park J made some interesting observations. First, while approving previous decisions about the meaning of ‘reconstruction’, he made it clear that these were all based on the specific facts and circumstances of those cases and those decisions could not be regarded as ‘ossifying the law’ in this area. In looking at the specifics of this case, it had been argued that the partition of F&M could not be a reconstruction because a reconstruction required one company to be reconstructed into a single successor company. Hence, the decisions in the Western Counties and South Wales Telephone and South African Supply and Cold Storage cases, each of which had a single successor company at the end of the schemes, could be distinguished from the Brooklands Selangor Holdings case where there were two successor companies and a partition of the company’s activities. But Park’s view was that it was not the number of successor companies that mattered, ie the partition of the activities was unimportant, it was the partition of the shareholder groups that determined that a transaction could not be a reconstruction. For example, if the business F&M had been partitioned into Locks and Pressings, but both successor companies had had the same shareholders as F&M, then, in Park’s opinion, 337

15.7 Introduction to reconstructions it would have been the case that substantially the same business was being carried out by substantially the same persons and the transactions could have amounted to a scheme of reconstruction following the South African Supply and Cold Storage case. However, the fact that each business was carried out by a different group of shareholders put the case firmly into Brooklands Selangor territory as not being a scheme of reconstruction.

MODERN TAX LEGISLATION 15.7 The Morgan’s Executors case had two main statutory consequences. On the first point of principle, the tax consequences of a concessionary treatment, TCGA 1992, ss 284A and 284B were introduced by FA 1999. These apply where a taxpayer receives a benefit by virtue of the application of a generally available concessionary treatment for capital gains purposes or for the purposes of corporation tax on chargeable gains. If the taxpayer subsequently repudiates the concessionary treatment, HMRC is entitled to recover the tax benefit by assessing a further gain in the later period when the concessionary treatment was repudiated. This rule only applies to pre-9 March 1999 concessions (or their replacements), presumably because any concessions published after that date incorporated appropriate provisions. In any case, HMRC now considers extra-statutory concessions to be an inappropriate mechanism for the operation of tax law, so all concessions are being legislated, where possible. It is also noteworthy that no similar provisions were enacted for income tax purposes. For the purposes of the subject matter of this book, however, by far the more important consequence of the decision in Morgan’s Executors was the fact that Parliament finally decided that it was no longer acceptable to rely on company law decisions and concessionary treatment for tax purposes and a statutory definition of a reconstruction was required. So the direct result of the case was the enactment of TCGA 1992, Sch 5AA in FA 2002.

CONCLUSION 15.8 This brief history demonstrates a number of important issues. First, we see the development of a body of jurisprudence in defining a term that is not defined in the legislation. This has a number of advantages, not least being the fact that these terms are often hard to define exactly and the definition can change over time as the commercial environment changes too. By letting judges determine what is or is not a reconstruction at any time, they can take 338

Introduction to reconstructions 15.9 into account both the specific facts and circumstances of the case and also the current commercial environment. This is far less easy if the courts are straitjacketed by a closely articulated definition. This concept of reconstruction that had developed for the purposes of commercial law was then co-opted by Parliament to another purpose, the will of Parliament in exempting certain transactions from tax. So when Parliament decided that stamp duty and, later, capital gains, should not apply to reconstructions, it was content for many years to leave the meaning of the term to the courts. This only changed when Parliament’s view of which transactions should be exempt from tax diverged from the judiciary’s view of what constitutes a reconstruction. At that point, it became necessary to find a way to apply the tax exemption to the wider range of transactions that included partitions too. Given the difficulties in defining such an amorphous concept as a scheme of reconstruction, the first attempt was simply to state that, for tax purposes, certain types of transaction would be treated as reconstructions even though they were not strictly so in law. It was only when that solution failed that Parliament was forced into detailed legislation for purely tax purposes. As a side issue, it is also at this point that the identity of the legislators becomes less obvious. Constitutionally1, it is Parliament that makes new laws and decides whether to tax certain transactions or to exempt them from tax. The role of HMRC is to advise Her Majesty’s government on these matters. Ministers then propose the appropriate new laws and these are debated by Parliament until a decision is reached. The authors’ experience of Revenue policy work suggests that the procedure for reducing the tax burden, such as by increasing the scope of the exemption for reconstructions by Statement D14 and SP 5/85, would only have involved a discussion of the matter between the Revenue policy advisers and ministers, ie government, and the decision would have been made without reference to Parliament. As a result, government ministers become the legislators, usurping the role of Parliament. In those ‘good old days’, where there was perhaps a greater degree of trust between the taxing authorities and the taxed, these occasional concessions by ministerial fiat may have been an acceptable compromise. Many commentators today, however, would argue that proper parliamentary scrutiny of all tax legislation should be reinstated.

1 Accepting, of course, that the UK does not have a constitution.

STAMP TAXES AND VAT 15.9 The stamp tax and VAT implications of the different forms of reconstruction are dealt with in the chapters following this. 339

Chapter 16

Definition of ‘reconstruction’

INTRODUCTION 16.1 As we have seen, after a long history in company law, the definition of reconstruction arising from the South African Supply and Cold Storage case was found to be inadequate for the purposes of tax law. As a result, a statutory definition was implemented in FA 2002 which is now TCGA 1992, Sch 5AA. It is also interesting to see that the Explanatory Notes to the new legislation specifically refer to the Morgan’s Executors case as the reason for this new legislation. Rather disingenuously, the notes say that that case established that ‘some types of corporate restructuring, which were previously accepted by the Inland Revenue as meeting the conditions for the “no-disposal” treatment, do not in law satisfy them’. This is something of a distortion of the real situation. It is clear from the previous chapter that neither the Inland Revenue nor the courts ever considered that a demerger involving the partition of the shareholders was a ‘reconstruction’ for company law purposes. That is why Statement D14 and its successor, SP 5/85, were necessary. The only reason that the Inland Revenue ever tried to argue that the transaction in Morgan’s Executors was a reconstruction was because it was the only argument that could be mounted against the taxpayer’s irrefutable position. If there was really any chance that the transaction could be found to be a reconstruction as a matter of company law – and therefore also a reconstruction for tax purposes too – the Inland Revenue could and would have taken the case further. Be that as it may, we now have a detailed definition of a ‘scheme of reconstruction’ for the purposes of tax legislation, so there is no longer a requirement to refer to the company law position.

OVERVIEW OF THE DEFINITION 16.2 The main point to bear in mind is that the definition was intended largely to codify the previous jurisprudence on the meaning of ‘reconstruction’ 340

Definition of ‘reconstruction’ 16.2 or ‘scheme of reconstruction’, preserving Buckley J’s dictum in the South African Supply and Cold Storage case, while adding the overlay that partitions should also qualify as schemes of reconstruction. So a fair summary of the definition is that it requires the business carried on by one or more original companies to be carried on by one or more successor companies and it requires the shareholders of the original company or companies, taken together, to be the same as the shareholders of the successor company or companies, taken together. The definition attempts to cover every possible restructuring of corporateowned businesses. So it covers the situations where: ●●

one company splits into more than one company, each carrying on part of the business carried on by the original (a demerger);

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two or more companies merge all their businesses into one company (a merger or amalgamation);

●●

two or more companies mix and merge their businesses into more than one company.

At the same time, the definition of ‘reconstruction’ requires the shareholder base to be essentially maintained even if it is split between more than one company. It is also worth noting from the outset that there is no requirement that a scheme of reconstruction involves only UK companies. Although the tax consequences of a scheme of reconstruction will only be relevant to a company or shareholder that is UK resident for tax purposes, the other companies involved in the scheme need not be UK resident. Indeed, for there to be any such restriction might offend against some of the fundamental freedoms required by the EU, such as freedom of establishment and free movement of capital, as well as against non-discrimination clauses in the UK’s double taxation treaties. So it is entirely possible to have, say, a scheme that involves all non-UK companies where the only person to whom the tax consequences matter is a UK resident individual shareholder, but so long as the appropriate conditions are satisfied for the scheme to constitute a scheme of reconstruction, the shareholder should be able to claim the benefits of the relevant exemptions. The more interesting aspect of these transactions can sometimes be in trying to demonstrate that transactions permitted by company law in other jurisdictions comply with the detailed requirements of the UK’s definition of a scheme of reconstruction. Indeed, it is not always exotic non-UK entities that raise these issues. One of the authors has been involved in extensive correspondence with HMRC over the merger of two industrial and provident societies. This process was, at the time, governed by specific provisions of the Industrial and Provident Societies Act 1965, which operated very differently from a Companies Act transaction. 341

16.3 Definition of ‘reconstruction’ We have tried to demonstrate the various parts of the definitions by reference to the cases that have already been discussed in detail wherever possible.

THE DEFINITION – TCGA 1992, SCH 5AA TCGA 1992, Sch 5AA, para 1 – introductory 16.3 ‘In section 136 “scheme of reconstruction” means a scheme of merger, division or other restructuring that meets the first and second, and either the third or the fourth, of the following conditions.’ Analysis 16.4 This introductory paragraph tells us that it is defining a ‘scheme of reconstruction’, although it is not clear that there is any fundamental difference between a scheme of reconstruction and a reconstruction per se. For the purposes of this chapter, we will use the terms interchangeably. It also tells us the type of transaction to which the Schedule applies, ie any ‘scheme of merger, division or other restructuring’. It seems unlikely, however, that a transaction or series of transactions that satisfied the detailed conditions of the Schedule would somehow fail to be a reconstruction by not being at least an ‘other restructuring’ or – even more far-fetched, perhaps – by not being a scheme! TCGA 1992, Sch 5AA, para 2 – first condition: issue of ordinary share capital 16.5 ‘The first condition is that the scheme involves the issue of ordinary share capital of a company (“the successor company”) or of more than one company (“the successor companies”) – (a) to holders of ordinary share capital of another company (“the original company”) or, where there are different classes of ordinary share capital of that company, to holders of one or more classes of ordinary share capital of that company (the classes “involved in the scheme of reconstruction”); or (b) to holders of ordinary share capital of more than one other company (“the original companies”) or, where there are

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Definition of ‘reconstruction’ 16.6 different classes of ordinary share capital of one or more of the original company or companies, to holders of ordinary share capital of any of those companies or of one or more classes of ordinary share capital of any of those companies (the classes “involved in the scheme of reconstruction”); and does not involve the issue of ordinary share capital of the successor company, or (as the case may be) any of the successor companies, to anyone else.’ Analysis 16.6 The fundamental requirement of a reconstruction is that there be an issue of ordinary share capital. This is important as a reconstruction at this level is about ownership of companies and their businesses. So issues of fixed rate capital or of debentures, which tend to be less concerned with proprietary rights over the issuing companies, are excluded from the definition of reconstructions. This does not mean that fixed rate shares or debentures cannot be issued in a scheme of reconstruction, however, and it will be clear from our analysis of TCGA 1992, s 136, for example, that they can. But there must be an issue of ordinary share capital for the scheme to qualify as a scheme of reconstruction in the first place. TCGA 1992, Sch 5AA, para 8(1) below tells us that the main definition of ordinary share capital is found in CTA 2010, s 1119. So ordinary share capital means issued share capital other than fixed rate shares with no other rights of participation. However, the definition of ordinary share capital for the purposes of a scheme of reconstruction is also extended by TCGA 1992, Sch 5AA, para 8(1) to include certain rights in relation to a unit trust scheme and also to interests of members in companies that do not have share capital. This last point is important as there are a number of different entities that do not have issued share capital. Examples include UK companies limited by guarantee, companies whose corporate status derives from a Royal Charter (such as the ICAEW or the CIOT) and companies created by Act of Parliament (such as the Mersey Docks and Harbour Board, sadly now wound up). Furthermore, as noted above, entities involved in a scheme of reconstruction need not be UK resident or incorporated. So the extension to interests of members in companies that do not have share capital ensures that non-UK entities that do not have something analogous to share capital (such as some US limited liability companies) are not excluded from schemes of reconstruction by virtue of their capital structure. The second fundamental point here is that the ordinary share capital of a successor company or companies is issued to the holders of ordinary share 343

16.6 Definition of ‘reconstruction’ capital of one or more original companies and to no one else. A reconstruction is not a way of bringing new shareholders into a company or companies. Again, it is still possible to introduce new shareholders to a company either before or after carrying out a scheme of reconstruction, but the scheme of reconstruction itself requires that shares of the successor company or companies are only issued to shareholders of the original company or companies. Finally, this part of the definition clearly envisages the possibility that there may be schemes of reconstruction affecting different classes of share in the original company or companies. This is best illustrated by looking at some of the examples we have already seen: ●●

in the Morgan’s Executors case, there were, in effect, two schemes of reconstruction; one where the Locks company issued ordinary share capital to the A shareholders of F&M and the other where the Pressings company issued ordinary share capital to the B shareholders of F&M;

●●

in the Brooklands Selangor Holdings case, there might have been a scheme of reconstruction affecting one class of shares of BSR, whereby ordinary share capital of Holdings was issued to the holders of that class of BSR’s ordinary share capital, but there would not have been a reconstruction affecting the class of shares held by PH, the majority shareholder.

These examples are discussed in more detail at the end of this chapter. Another point of interest relating is that it is only TCGA 1992, Sch 5AA that concentrates on ordinary share capital. TCGA 1992, s 136, as we shall see, has no such requirement. As long as ordinary share capital of a successor company is issued in respect of any class of ordinary share capital of an original company, the scheme can be a scheme of reconstruction. By TCGA 1992, s 136, the successor company can then also issue fixed rate shares, debentures and so on to implement the rest of the scheme. We have, for example, seen a scheme of reconstruction where only 0.04 per cent by value of the ordinary share capital of the original company was of a class involved in a scheme of reconstruction carrying an entitlement to an issue of ordinary share capital by the successor company. All other classes of share capital of the original company were classes whereby the shareholders had an entitlement to an issue of either fixed rate preference shares or of debentures. This was an unusual case, to say the least! This does lead to a question as to whether HMRC would ever refuse clearance under TCGA 1992, s 138 in respect of such a scheme of reconstruction on the basis of the very small proportion of ordinary share capital of the original company involved in the scheme of reconstruction. Our experience is that a

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Definition of ‘reconstruction’ 16.8 refusal simply because the proportion is low is unlikely, so long as the scheme is being carried out for bona fide commercial reasons and not to avoid any of the prescribed taxes. What is more likely is that clearance might be refused if the only reason there were any shares of the original company involved in the scheme of reconstruction was to ensure that the first condition of TCGA 1992, Sch 5AA was satisfied. In such a case, there would be no commercial reason for structuring the scheme that way except to qualify as a scheme of reconstruction and HMRC might consider itself entitled to refuse the exemption on the basis of there being a tax avoidance motive. TCGA 1992, Sch 5AA, para 3 – second condition: equal entitlement to new shares 16.7 ‘(1) The second condition is that under the scheme the entitlement of any person to acquire ordinary share capital of the successor company or companies by virtue of holding relevant shares, or relevant shares of any class, is the same as that of any other person holding such shares or shares of that class. (2) For this purpose “relevant shares” means shares comprised – (a) where there is one original company, in the ordinary share capital of that company or, as the case may be, in the ordinary share capital of that company of a class involved in the scheme of reconstruction; (b) where there is more than one original company, in the ordinary share capital of any of those companies or, as the case may be, in the ordinary share capital of any of those companies of a class involved in the scheme of reconstruction.’ Analysis 16.8 This condition requires that the entitlement of any one holder of ordinary share capital of a particular class in an original company is the same as that of any other shareholder of shares of that class in that company. It is a fundamental principle of both corporate reorganisations and reconstructions that they are matters relating to the shares and shareholders of the companies and all shares of the same class carry the same rights for all their shareholders: if the rights of the shareholders were different, then the shares would de facto be shares of different classes1. So since a scheme of reconstruction is a matter of shareholder rights, the rights of all shareholders must be preserved.

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16.8 Definition of ‘reconstruction’ One potential problem area we have seen postulated in relation to the condition is that the entitlement test appears to be exact, which contrasts with provisions that refer to issues of shares ‘in proportion to (or as nearly as may be in proportion to) [the] relevant holdings’ in the original company or companies2. So imagine a scheme where the successor company is to issue one share in respect of every 10 shares held in the original company. For the purposes of TCGA 1992, s 136, any small residual holdings of fewer than 10 shares can be ignored on the basis of the share issue being as nearly as may be pro rata, but the entitlement test in this second condition of TCGA 1992, Sch 5AA does not appear to allow this degree of latitude, so the scheme might not qualify as a scheme of reconstruction. We believe this position to be incorrect. Our reasoning is that TCGA 1992, Sch 5AA, para 3 refers to entitlement, not allocation, issue or similar terms. In the example given, every holder of ordinary shares in the original company has the same entitlement to shares in the successor company, ie one of the latter for every 10 of the former. Since they have the same entitlement, the second condition is satisfied even if, taking residual holdings of fewer than 10 shares into account, the actual issue of shares by the successor company is not precisely pro rata to the shareholdings in the original company3. In any case, this would be a very unusual situation and none of the authors have yet come across a situation where it was commercially essential to issue fewer shares of the successor company than are held in the original company. Furthermore, as we shall see later, the rights of shareholders can be varied by a preliminary reorganisation of share capital into different classes. So this condition might be seen as administrative rather than technically onerous. The wider point is that the overall result of complying with the first and second conditions is to preserve the shareholder base throughout the scheme of reconstruction, ie the shareholders of the original company or companies, taken together, are the same as the shareholders of the successor company or companies. So the definition of a scheme of reconstruction satisfies Buckley J’s requirement that ‘substantially the same persons’ be involved.

1 For the avoidance of doubt, we would note that shareholders’ agreements can also affect the rights of some shareholders, for example, to deal with their shares in different ways, receive dividends, etc, but these are the products of the shareholders’ agreements and not of the shares themselves. 2 See, for example, TCGA 1992, s 126 (Chapter 6) and TCGA 1992, s 136 (Chapter 18). 3 We have also come across a similar situation where tax counsel gave an opinion that the principle of de minimis non curat lex (the law does not concern itself with trivia) might apply here in any case, ie a small difference might be ignored for the purposes of TCGA 1992, Sch 5AA regardless of the exact wording of the legislation. We have never seen HMRC accept the de minimis principle before and we would be reluctant to rely on it here.

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Definition of ‘reconstruction’ 16.11 TCGA 1992, Sch 5AA, para 4 – third condition: continuity of business 16.9 The third condition is complex, so we will look at it in discrete parts. Overall, however, this condition essentially requires that the scheme of reconstruction satisfies Buckley J’s ‘substantially the same business’ test. TCGA 1992, Sch 5AA, para 4(1)(a) – one original company 16.10 ‘(1) The third condition is that the effect of the restructuring is – (a) where there is one original company, that the business or substantially the whole of the business carried on by the company is carried on – (i)

by a successor company that is not the original company; or

(ii) by two or more successor companies (which may include the original company);’ Analysis 16.11 TCGA 1992, Sch 5AA, para 4 starts with the situation where there is only one original company in the scheme of reconstruction. The components of TCGA 1992, Sch 5AA, para 4(1) can be broken down as follows: ●●

a single original company might be reconstructed into a single successor company as envisaged by TCGA 1992, Sch 5AA, para 4(1)(a)(i). In this case, there is prima facie only a scheme of reconstruction if the successor company is a different company from the original company. However, this need not be the case, because of the effect of TCGA 1992, Sch 5AA, para 4(3), below. An example is the first transaction in the South African Supply and Cold Storage case where SACo was reconstructed into AusCo;

●●

a single original company might be reconstructed into more than one successor company as envisaged by TCGA 1992, Sch 5AA, para 4(1) (a)(ii). In this scenario, part of the business can continue to be carried on in the original company, but this need not be the case. So, for example, in the Brooklands Selangor Holdings and Morgan’s Executors cases, a single original company was reconstructed into more than one successor company. In the former, BSR retained part of its business after transferring part to Holdings, but in the Morgan’s Executors case, the original company was wound up and no part of the business was carried on by the original company after the reconstruction.

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16.12 Definition of ‘reconstruction’ TCGA 1992, Sch 5AA, para 4(1)(b) – more than one original company 16.12 ‘(b) where there is more than one original company, that all or part of the business or businesses carried on by one or more of the original companies is carried on by a different company, and the whole or substantially the whole of the businesses carried on by the original companies are carried on – (i)

where there is one successor company, by that company (which may be one of the original companies); or

(ii) where there are two or more successor companies, by those companies (which may be the same as the original companies or include any of those companies).’ Analysis 16.13

The components of this condition can be broken down as follows:

●●

two or more original companies might be merged into a single successor company as envisaged by TCGA 1992, Sch 5AA, para 4(1)(b)(i). In this case, the successor company may be one of the original companies, but it need not be. For example, in the second transaction in the South African Supply and Cold Storage case, AusCo was amalgamated with Imperial, so we have two original companies merging into one successor company, which was also one of the original companies;

●●

two or more original companies might be reconstructed into more than one successor company as envisaged by TCGA 1992, Sch 5AA, para 4(1)(b)(ii). None of the transactions we have looked at so far has encompassed this situation, and we have not seen this in practice, but it looks very much like the merger by formation of a new company described in Chapter 4.

Taking TCGA 1992, Sch 5AA, para 4(1) and (2) together, however, it is clear that one effect of a scheme of reconstruction is that at least part of a business must be carried on after the reconstruction by a company that was not carrying on that business or part business before the reconstruction, or be deemed to be so carried on (see TCGA 1992, Sch 5AA, para 4(3)). TCGA 1992, Sch 5AA, para 4(2) – meaning of business separations 16.14 ‘(2) The reference in sub-paragraph (1)(a)(ii) or (b)(ii) to the whole or substantially the whole of a business, or businesses, being carried on 348

Definition of ‘reconstruction’ 16.15 by two or more companies includes the case where the activities of those companies taken together embrace the whole or substantially the whole of the business, or businesses, in question.’ Analysis 16.15 TCGA 1992, Sch 5AA, para 4(2) clarifies the meaning of a business being carried on by more than one successor company. The wording of the provision is not entirely clear, but HMRC’s Capital Gains Manual (at CG52707C) tells us that this simply means that the activities of the successor companies are to be considered altogether in considering whether those activities constitute the whole or substantially the whole of the activities carried on by the original company or companies prior to the reconstruction. The Manual gives a very simple example: imagine an original company with a retail and a manufacturing trade. This company is subject to a scheme of reconstruction whereby one successor company carries on the retail trade and another carries on the manufacturing trade. Taking the overall activities of the successor companies together, they constitute the whole of the activities of the original company. From our experience, more complex scenarios can also qualify and the business activities carried on by the successor companies need not be identifiably the same activities as those carried on by the original company or companies. The HMRC Capital Gains Manual also has some helpful comments on the meaning of ‘business’ at reference CG52709. The Manual notes that whether a company or companies carry on a business is a question of fact. However, there is a useful example of a company with an investment business. The example shows that HMRC believes that the mere holding of investments does not constitute a business: to amount to a business, there must be a management component to the activities, too. We do not wholly agree with this analysis but we have also never had a problem with it in practice. Taking the example given in CG52709, if a reconstruction transferred the investments to a successor company, leaving the investment management business with the original company, the successor company would not be carrying on a business at all, by this analysis, so the tests at TCGA 1992, Sch 5AA, para 4(1)(a)(ii) or (b)(ii) would not be satisfied and the scheme would not be a scheme of reconstruction. But we have never seen a scheme where the management of investments is segregated away from the investments themselves.

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16.16 Definition of ‘reconstruction’ TCGA 1992, Sch 5AA, para 4(3) – group companies 16.16 ‘(3) For the purposes of this paragraph a business carried on by a company that is under the control of another company is treated as carried on by the controlling company as well as by the controlled company.

Section 1124 of CTA 2010 (meaning of “control”) applies for the purposes of this sub-paragraph.’

Analysis 16.17 TCGA 1992, Sch 5AA, para 4(3) effectively tells us to regard the activities of companies under the control of another company as being carried out by either or both companies. This provision ensures that schemes do not fail to be schemes of reconstruction simply because any of the original or successor companies are pure holding companies, ie not actually carrying on any business. It is interesting to note, however, that the Schedule uses the control tests of CTA 2010, s 1124 – by holdings of share capital, voting power, the articles of association or other document – as most capital gains matters relating to groups of companies use the economic rights tests of TCGA 1992, s 170. This provision is also useful in a number of practical situations. For example, putting a new holding company in placed may not be practical by share exchange, often because of stamp duty issues. In such cases, this might be done by cancelling the shares of the existing company (under CA 2006, s 641) and issuing new shares to the new holding company, which issues shares to the original shareholders. The economic result is a new holding company, although the group’s activity is still carried on by the same company or companies as before, which would appear to fail the requirements of the third condition. However, since the new holding company is deemed, by TCGA 1992, Sch 5AA, para 4(3), to be carrying on the activities of any companies under its control, that new company can also be considered to be a successor to the business activities, thus satisfying the third condition after all. This analysis has been accepted by HMRC’s clearance team. TCGA 1992, Sch 5AA, para 4(4) – provision for winding up, etc 16.18 ‘(4) For the purposes of this paragraph the holding and management of assets that are retained by the original company, or any of the original 350

Definition of ‘reconstruction’ 16.21 companies, for the purpose of making a capital distribution in respect of shares in the company shall be disregarded.

In this sub-paragraph “capital distribution” has the same meaning as in section 122.’

Analysis 16.19 This provides for the situation where an original company is to be wound up as part of the scheme of reconstruction and retains assets in order to make capital distributions. Absent this provision, the company might otherwise fail the requirements of TCGA 1992, Sch 5AA, para 4(1) that there is a transfer of at least substantially the whole of the business carried on by the original company or companies. For example, what if a company transfers its trade to a successor company, but retains some assets to balance the books? If the retained assets are material in value, there might be a view that the company has not transferred substantially the whole of its business to a successor company. So TCGA 1992, Sch 5AA, para 4(4) permits amounts retained for capital distributions to shareholders to be disregarded for the purposes of this condition. TCGA 1992, Sch 5AA, para 5 – fourth condition: compromise or arrangement with members 16.20 ‘The fourth condition is that – (a) the scheme is carried out in pursuance of a compromise or arrangement – (i)

to which Part 26 of the Companies Act 2006 (arrangements and reconstructions) applies,

(ii) under any corresponding provision of the law of a country or territory outside the United Kingdom, and (b) no part of the business of the original company, or of any of the original companies, is transferred under the scheme to any other person.’ Analysis 16.21 This condition requires that the scheme be carried out pursuant to certain types of arrangement under the UK Companies Act or similar provisions applicable in other jurisdictions. The UK legislation is now (broadly) found in CA 2006, ss 895 and 899, discussed in overview in Chapter 17. It is interesting, however, to ponder precisely what is meant or intended by ‘any corresponding

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16.22 Definition of ‘reconstruction’ provision’ of another jurisdiction as we are not aware of this having been tested with HMRC since the provision became law. This paragraph also requires that no other person receives any part of the business or businesses of the original company or companies. So in a case where TCGA 1992, Sch 5AA, para 5 is relied on, it is not sufficient that substantially the whole of the business of the original company or companies be carried on by the successor company or companies. While this provision does not necessarily require that the whole of the business must end up with the successor company or companies, it does mean that any minor part of the business that is not transferred must simply be closed down, and cannot be transferred to a third person. It is not clear from the legislation or other published material why this more restrictive requirement is imposed on this fourth condition and not on the third condition. This may be irrelevant in many cases. If there is a scheme or arrangement under CA 2006, Part 26 and most, but not all, of the business is transferred to one or more successor companies, the reconstruction is likely to satisfy the third condition even if it fails the fourth condition because of TCGA 1992, Sch 5AA, para 5(b). Since only one of the third and fourth conditions has to be satisfied, this would be sufficient for the scheme to be a scheme of reconstruction. TCGA 1992, Sch 5AA, para 6 – preliminary reorganisation of share capital to be disregarded 16.22 ‘Where a reorganisation of the share capital of the original company, or of any of the original companies, is carried out for the purposes of the scheme of reconstruction, the provisions of the first and second conditions apply only in relation to the position after the reorganisation.’ Analysis 16.23 TCGA 1992, Sch 5AA, para 6 says that the scheme of reconstruction does not start until after there has been any preliminary reorganisation of the share capital of the original company or companies. For example, in the Morgan’s Executors case, there was a reorganisation of the share capital of F&M into A and B shares entitling the shareholders to interests in either the Locks or the Pressings business. This is one of the most common first steps in any scheme of demerger where there is to be a partition of the shareholders as, without it, there is no legal basis for the transfer of different assets to companies issuing shares to different groups of shareholders.

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Definition of ‘reconstruction’ 16.24 If this preliminary reorganisation were to be considered part of the scheme of reconstruction, however, a scheme of partition could fail to qualify as a scheme of reconstruction. Taking the Morgan’s Executors case as our example, again, when the Locks company issued ordinary share capital to Norman Morgan and the Pressings business issued ordinary share capital to Barrie Morgan, it could be argued that the holders of the ordinary share capital of F&M had not had the same entitlement to acquire shares of the successor companies since Norman was not entitled to Pressings shares and Barrie was not entitled to Locks shares, although they all held shares of the same class in F&M. Thus, the second condition in TCGA 1992, Sch 5AA, para 3 would not have been satisfied. The simplest way, therefore, to resolve this issue, given the commercial necessity for preliminary reorganisations in many schemes, is to ignore the preliminary reorganisation completely and assume that the scheme of reconstruction only starts after that reorganisation has been completed. TCGA 1992, Sch 5AA, para 8(2) explains that ‘reorganisation’ in this context means a reorganisation within the meaning of TCGA 1992, s 126, discussed in more detail in Chapter 6. This might suggest that transactions deemed to be reorganisations by other provisions, such as TCGA 1992, ss 135 and 136, cannot be considered as reorganisations for this purpose and disregarded. But the better analysis is that any such transactions are deemed to be reorganisations within TCGA 1992, s 126, so that this definition just avoids any difficulty with the meaning of ‘reorganisation’. To date, our experience has not suggested that this point has caused any specific difficulty. TCGA 1992, Sch 5AA, para 7 – subsequent issue of shares or debentures to be disregarded 16.24 ‘An issue of shares in or debentures of the successor company, or any of the successor companies, after the latest date on which any ordinary share capital of the successor company, or any of them, is issued – (a) in consideration of the transfer of any business, or part of a business, under the scheme; or (b) in pursuance of the compromise or arrangement mentioned in paragraph 5(a); shall be disregarded for the purposes of the first and second conditions.’

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16.25 Definition of ‘reconstruction’ Analysis 16.25 This provision helps to determine the end of a scheme of reconstruction in much the same way that TCGA 1992, Sch 5AA, para 6 might be said to determine when a scheme of reconstruction starts. The scheme of reconstruction is effectively deemed complete after the final date for the issue of any ordinary share capital by the successor company or companies under the scheme. Any issue of shares or debentures after that date is ignored in determining whether the first and second conditions are satisfied. Without this provision, a number of matters might impact on the apparent satisfaction of the first or second conditions. For example: ●●

an issue of shares to new subscribers in a successor company might contravene the first condition that only holders of shares in the original company or companies should be entitled to shares in the successor company or companies;

●●

an issue of further shares to an existing shareholder might contravene the second condition that the entitlement to shares in the successor company or companies should be pro rata to the holdings of shares in the original company or companies;

●●

an issue of fixed rate shares or debentures by a successor company might contravene the requirement of the first condition that only ordinary share capital be issued under the scheme of reconstruction.

TCGA 1992, Sch 5AA, para 8 – interpretation 16.26 ‘(1) In this Schedule “ordinary share capital” has the meaning given by section 1119 of CTA 2010 and also includes – (a) in relation to a unit trust scheme, any rights that are treated by section 99(1)(b) of this Act (application of Act to unit trust schemes) as shares in a company; and (b) in relation to a company that has no share capital, any interests in the company possessed by members of that company. (2) Any reference in this Schedule to a reorganisation of a company’s share capital is to a reorganisation within the meaning of section 126.’

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Definition of ‘reconstruction’ 16.28 Analysis 16.27 The analysis of this paragraph has been discussed previously in the analyses of TCGA 1992, Sch 5AA, paras 2 and 6.

CONCLUSION 16.28 Now that we have a codified definition of a scheme of reconstruction, we can look at the reliefs from tax that require there to be a scheme of reconstruction as a condition precedent. These reliefs are TCGA 1992, Sch 5AA, ss 136 and 139, equating to the original provisions in FA 1962, Sch 9, para 13(1) and (2) respectively and FA 1965, Sch 7, para 7(1) and (2) respectively. Before that, however, we should have a brief look at the company law provision referred to in the fourth condition of TCGA 1992, Sch 5AA, ie CA 2006, Part 26.

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Chapter 17

Company compromises or arrangements

INTRODUCTION 17.1 The fourth condition of TCGA 1992, Sch 5AA in paragraph 5 refers to a scheme ‘carried out in pursuance of a compromise or arrangement to which Part 26 of the Companies Act 2006 (arrangements and reconstructions) applies’ (CA 2006, Part 26). CA 2006, Part 26 provides a procedure for companies to come to a binding ‘compromise or arrangement’ with all of its creditors or members (or any classes of them). This procedure is commonly known as a scheme of arrangement and we discuss some of the relevant provisions contained in CA 2006, Part 26 here in this chapter. However, please note that this is only an overview and should not be taken as a definitive text on matters of company law.

CA 2006, SS 895 AND 899 – APPLICATION AND COURT SANCTION FOR COMPROMISE OR ARRANGEMENT 17.2 The essence of these provisions is that, if the requisite member and/or creditor consent is obtained, a court can sanction any compromise or arrangement proposed between a company and (a) its members or (b) its creditors (CA 2006, s 899(1)). The compromise or arrangement must be agreed to by a majority in number representing at least 75 per cent by value of the creditors (or class of creditors) or members (or class of members) voting at appropriately convened meeting(s) of creditors or members, as appropriate (CA 2006, s 899(1)). Once the appropriate level of creditor or member consent has been achieved and the court has sanctioned the compromise or arrangement, it is binding on all members (or class of members) or creditors (or class of creditors), whether or not they voted in favour of the compromise or arrangement, or indeed voted at all, and is also binding on the company (CA 2006, s 899(3)).

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Company compromises or arrangements 17.2 As hinted above, in determining whether a scheme of arrangement falls within the ambit of CA 2006, Part 26, it is necessary for the court to be satisfied that the proposed scheme amounts to a ‘compromise or arrangement’ between the company and its creditors or members (or any classes of them) in accordance with CA 2006, s 895. CA 2006, Part 26 does not specify which types of transaction will constitute a ‘compromise or arrangement’, although CA 2006, s 895(2) tells us that ‘arrangement’ includes ‘a reorganisation of the company’s share capital by the consolidation of shares of different classes or by the division of shares into shares of different classes, or by both of those methods’. As such, a scheme of arrangement under CA 2006, s 895 would, for tax purposes, probably include a reorganisation within TCGA 1992, s 126 (see Chapter 6). Although it is important to note that CA 2006, s 895(2) is not an exhaustive definition of ‘arrangement’ and, in practice, it is rare for a scheme of arrangement to be put forward for the consolidation or division of shares, given that this sort of capital reorganisation can easily be effected by a shareholder resolution under CA 2006, s 618 without the need to resort to the more complicated, court-approved scheme of arrangement process. For there to be a ‘compromise’ or ‘arrangement’ for the purpose of CA 2006, s 895, there must be an element of ‘give and take’ between the company and its creditors or members (or any classes of them)1. Accordingly, the content of a scheme of arrangement can consist of almost anything which the company and its creditors or members can lawfully agree between themselves, except for a transaction under which the right of the creditors or members is surrendered without any commensurate consideration being offered in exchange. The best illustration of the operation of a scheme of arrangement under CA 2006, s 895 is to give an example: Let us assume a single company, company A, is to be acquired by company B in return for an issue of shares by company B to the shareholders of company A. This share-for-share exchange could be effected by way of a transfer scheme of arrangement (a ‘transfer scheme’) between company A and all of its shareholders, pursuant to which all of the shareholders would be required to transfer their shares in company A to company B, on terms that company B would allot and issue new shares to the shareholders of company A as consideration for the shares in company A. Upon completion of the transfer scheme, company B would acquire control of the entire issued share capital of company A (see Figure 17.1(a)). It should be noted that, on a transfer scheme, consideration does not necessarily have to be in the form of shares. Company B could also provide consideration in the form of cash, loan notes or other securities (or a combination of any of them) in return for the acquisition of the entire issued capital of company A.

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17.2 Company compromises or arrangements Figure 17.1(a)

Prior to March 2015, the acquisition of company A could have been effected by way of a cancellation scheme of arrangement (a ‘cancellation scheme’) in which all of company A’s shares would have been cancelled (by way of a reduction of share capital pursuant to CA 2006, Part 17, Chapter 10) and reissued to company B (thereby giving company B control in consideration for company B paying the former shareholders of company A the agreed consideration for each of their shares cancelled). However, on 4 March 2015, the Companies Act 2006 (Amendment Part 17) Regulations 2015 (SI 2015/472) were published. These regulations amended CA 2006, s 641, thereby preventing the use of a reduction of capital as part of a scheme of arrangement for company takeovers, which enabled companies to avoid paying stamp duty by cancelling the target company’s shares and reissuing them directly to the acquiring company. This prohibition does not apply where the following conditions are met: (a) the scheme is to insert a new parent undertaking for the company; (b) all or substantially all of the members of the company become members of the parent undertaking; and (c) the members of the company are to hold proportions of the equity share capital of the parent undertaking in the same or substantially the same proportions as they hold the equity share capital of the company. As a result of the above, any takeovers that use CA 2006, Part 26 should generally be structured as ‘transfer schemes’, rather than ‘cancellation schemes’, unless the acquisition amounts to a reorganisation that inserts a new holding company (see Figure 17.1(b)).

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Company compromises or arrangements 17.3 Figure 17.1(b)

1 Cf Re Alabama, New Orleans, Texas and Pacific Junction Railway Co [1891] 1 Ch 213; Re Savoy Hotel Ltd [1981] Ch 351; and Re T&N Ltd [2006] EWHC 1447 (Ch).

Benefits of the use of a scheme of arrangement under CA 2006, Part 26 17.3 The use of CA 2006, Part 26 is somewhat cumbersome, given the specific legal administrative requirements of the CA 2006, but there are a number of potential advantages which can make a scheme of arrangement the better way forward. The most commonly seen benefit of a scheme of arrangement is the lower level of approval required in order to secure 100 per cent of the shares. A share-for-share exchange (if structured as a takeover offer) requires the agreement of 90 per cent by value of the members of a company to which the share-for-share exchange offer relates. Only then can the holders of the remaining 10 per cent of the shares be compulsorily required to sell their shares. In contrast, a scheme of arrangement under CA 2006, Part 26 only requires the agreement of a majority in number representing at least 75 per cent by value of the members who attend the meeting (or arrange for a proxy vote) to bind all the remaining members of the company. Therefore, the voting requirements under a scheme of arrangement are far less onerous and often quicker than other compulsory acquisition procedures and can make it easier to pass the appropriate resolutions where there are large numbers of shareholders. This can be particularly apposite with public companies, where it can be difficult to get to the 90 per cent threshold given the difficulty to get many shareholders to take any interest at all in the affairs of the 359

17.4 Company compromises or arrangements company. In addition, if there are overseas shareholders (for example, in the US) to whom an offer cannot be made for regulatory reasons, or shareholders who are untraceable (and therefore cannot consent to the share for share exchange), a scheme of arrangement can be structured to cater for them.

When the use of CA 2006, Part 26 is not required 17.4 Schemes of arrangement under CA 2006, Part 26 are generally complex, time-consuming and costly procedures and there is no guarantee that the court will sanction the scheme (although, in practice, it is relatively rare for the court not to do so). There are clearly occasions when it is necessary to use CA 2006, Part 26 in order to carry out commercial transactions. However, for the majority of us who work mainly with owner-managed companies, the companies are very likely to have very few shareholders, sometimes only one and rarely more than half a dozen, so there is no problem getting unanimous votes of the shareholders to carry out transactions. Therefore, for these sorts of companies, it may not be necessary to use CA 2006, Part 26. Turning this around, we routinely use cancellation schemes for transactions involving owner-managed companies, where a scheme of arrangement under CA 2006, s 895 would not be permitted under SI 2015/472 (see above).

CA 2006, S 900 – POWERS OF COURT TO FACILITATE RECONSTRUCTION OR AMALGAMATION 17.5 Whilst CA 2006, s 895 appears very wide-ranging in its scope and can be used for a variety of schemes of arrangement between a company and its creditors or members, we note that a scheme sanctioned under CA 2006, s 895 is distinct from a scheme sanctioned under CA 2006, s 900, which can only be used by companies formed and registered under CA 2006 (by virtue of CA 2006, s 895(2)(a)) in order to facilitate a ‘reconstruction’ of one or more companies, or the ‘amalgamation’ of two or more companies (a ‘section 900 scheme’). This is, of course, very relevant to our discussions on company reconstructions for tax purposes. In order to see how this provision works, we thought it worth setting out in its entirety: ‘(1) This section applies where application is made to the court under section 899 to sanction of a compromise or arrangement and it is shown that – (a) the compromise or arrangement is proposed for the purposes of, or in connection with, a scheme for the reconstruction of any 360

Company compromises or arrangements 17.5 company or companies, or the amalgamation of any two or more companies, and (b) under the scheme the whole or any part of the undertaking or the property of any company concerned in the scheme (“a transferor company”) is to be transferred to another company (“the transferee company”). (2) The court may, either by the order sanctioning the compromise or arrangement or by a subsequent order, make provision for all or any of the following matters – (a) the transfer to the transferee company of the whole or any part of the undertaking and of the property or liabilities of any transferor company; (b) the allotting or appropriation by the transferee company of any shares, debentures, policies or other like interests in that company which under the compromise or arrangement are to be allotted or appropriated by that company to or for any person; (c)

the continuation by or against the transferee company of any legal proceedings pending by or against any transferor company;

(d) the dissolution, without winding up, of any transferor company; (e)

the provision to be made for any persons who, within such time and in such manner as the court directs, dissent from the compromise or arrangement,

(f)

such incidental, consequential and supplemental matters as are necessary to secure that the reconstruction or amalgamation is fully and effectively carried out.’

The procedural rules and steps for a section 900 scheme are broadly the same as those required for a scheme of arrangement under CA 2006, s 895 (ie an application must still be made to the court and the scheme must be approved by 75 per cent by value of the creditors or members (or any classes of them)). However, there are some important distinctions: (1) A section 900 scheme must relate to an ‘amalgamation’ or ‘reconstruction’ which would result in the whole or part of the business or property of one company being transferred to another company (CA 2006, s 900(1)(a), (b)). The terms ‘amalgamation’ and ‘reconstruction’ are not defined in CA 2006; however, English case law provides guidance as to how these terms would likely be construed by the courts and are considered in more detail in Chapters 15 and 19 respectively1. (2) Following the amalgamation or reconstruction, the transferor company and the transferee company must have substantially the same shareholders 361

17.6 Company compromises or arrangements as one another2. This requirement for commonality of shareholders means that a scheme under CA 2006, s 900 cannot be used to implement any takeover offers, partition demergers or any restructurings involving an exchange of debt for equity3. In this respect, the scope of CA 2006, s 900 is a lot more restrictive than CA 2006, s 895. (3)

The court has the ability to make certain consequential orders to facilitate the reconstruction or amalgamation under a section 900 scheme, either within the terms of the scheme of arrangement itself or by subsequent order. The matters for which a court order may make provision include the transfers of assets, the allotment of consideration shares as well as the dissolution, without winding up, of the transferor company. The court may only approve a section 900 scheme where there are no impediments to the transfer of the business and assets. As such, if there were, for example, contracts which included a prohibition on transfer, the consent to the transfer of those contracts would need to be obtained prior to the court approving the section 900 scheme.

As discussed in Chapter 4, the CA 2006 provisions governing the section 900 scheme are ways in which English companies can be combined or ‘merged’ with one company being wound up without liquidation. However, these provisions have rarely to date been used where the shareholders and/or creditors are predominantly intra group. This is because the courts have taken the view that there is no need for their jurisdiction to sanction a compromise or arrangement where there is already unanimity between shareholders and/ or creditors. However, the success of the EU cross-border merger regime (which has been widely used in an intra-group context) has made this position increasingly anomalous. The courts have therefore started to be more flexible if it can be shown that there is a compelling commercial rationale for the use of CA 2006, s 900 in an intra-group context rather than other reorganisation methods (such as business transfer and liquidation). The courts have accepted tax efficiency as a sufficient reason, as long as there is an underlying business rationale for the reorganisation itself.

1 Cf Re South African Supply and Cold Storage Co [1904] 2 Ch 268 (at 286–287); and Re MyTravel Group plc [2004] EWHC 2741 (Ch) and [2004] EWCA Civ 1734. 2 Re South African Supply and Cold Storage Co [1904] 2 Ch 268 (at 286). 3 Cf Re MyTravel Group plc [2004] EWHC 2741 (Ch) and [2004] EWCA Civ 1734.

CONCLUSION 17.6 Most tax people seem to be unaware of CA 2006, s 900, or its predecessors, and its relationship with CA 2006, ss 895 and 899. But there are 362

Company compromises or arrangements 17.8 a number of transactions, including both mergers and demergers, that could be carried out within the parameters of these provisions. While CA 2006, s 900 is only available for the sanctioning of non-partition demergers, we believe that the courts could sanction a partition demerger under the CA 2006, s 895 / 899 procedure anyway. The major advantage of CA 2006, s 900 might simply be to facilitate the elimination of unrequired transferor companies by dissolution without liquidation in qualifying cases.

VALUE ADDED TAX 17.7 If a transfer scheme is used to effect a takeover of one company by another (as in Figure 17.1(a)), the position is as follows:

Position of the sellers 17.8 In a reconstruction of the type described the first question, as always, is whether the sellers are carrying on a relevant business in relation to their shares in A (using the same lettering as in Figure 17.1(a)). If they are not, no input VAT which they incur will be recoverable. If they are carrying on a relevant business, their position differs from that of the sellers in a share-for-share exchange (8.24) in that they do not transfer their shares in A: those shares are cancelled. At first sight, therefore, they make no supply, they simply suffer a cancellation. Nevertheless, in our view HMRC would have a respectable argument for arguing that, looking at the substance of the matter, the sellers are indeed doing something, making a supply of their shares, in consideration of a receipt of shares in B. On the other hand the fact that the transaction is imposed by the court rather than done by way of a consensual contract is a pointer in the other direction. This is uncharted territory for VAT so far as we are aware. However, even if they are making an exempt supply of shares, in some cases their costs will be attributable to their own continuing business and, if so, if that is taxable, their input VAT will be recoverable as general overhead, see 8.24. If the proper interpretation is that they are making no supply their input VAT will be general overhead, so this should normally be the argument the sellers should advance. If on the other hand, the buyer belongs outside the EU the reverse is true: making an (effectively zero-rated) supply to the buyer would give the better result. It is suggested that the Sellers fill in their VAT returns on the basis of the more favourable analysis, but explain to HMRC what is happening so that HMRC cannot claim to have been kept in ignorance of the facts. 363

17.9 Company compromises or arrangements

The position of the buyer 17.9 The buyer’s (B in Figure 17.1(b)) position is the same as in the case of a transfer scheme (in Figure 17.1(a)); see 8.26–8.28.

The position of Target 17.10 Target (A in Figure 17.1(b)) cancels its shares and issues new ones, but makes no supply for VAT, because an issue of shares is not a supply: Kretztechnik AG v Finanzamt Linz [2005] STC 1118, ECJ. Any input VAT it incurs on the costs of the exercise will be residual input VAT of its business.

STAMP TAXES 17.11 No stamp taxes should arise on the cancellation of existing shares and the issue of new shares.

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Chapter 18

The UK reconstruction reliefs

INTRODUCTION 18.1 In the previous chapters, we have looked at the development of the meaning of ‘reconstruction’ culminating in the statutory definition of a ‘scheme of reconstruction’ in TCGA 1992, Sch 5AA. We have also looked briefly at the exemptions from the taxation of capital gains for schemes of reconstruction at both shareholder and company level. We will now look at the provisions for reliefs for UK domestic transactions in more detail. We will review the reliefs available for certain cross-border transactions within the EU in Chapter 26. The first is the relief for shareholders and certain creditors afforded by TCGA 1992, s 136. We will then look at the relief for companies transferring businesses in a scheme of reconstruction and the analogous provisions relating to transfers of intangible fixed assets in CTA 2009, Part 8.

TCGA 1992, S 136 – SHAREHOLDER AND CREDITOR RECONSTRUCTION RELIEF 18.2 As discussed earlier, this provision was introduced originally as an exemption from the taxation of short-term gains in 1962 (FA 1962, Sch 9, para 13(1)) and re-enacted in the capital gains legislation of 1965 in identical form (FA 1965, Sch 7, para 7(1)). Although it has been split into rather more separate clauses over the years, TCGA 1992, s 136(1) and (2) are easily recognisable as being the same basic piece of legislation. Why is a relief needed for this sort of transaction? To answer this, let us look at a simple reconstruction: company A transfers all its assets to a new company, company B, in consideration for which company B issues shares to the shareholders of company A (see Figure 18.1, very similar to the first transaction in the South African Supply and Cold Storage case). In the first case, let us suppose that these transactions are carried out as part of a winding up of company A. So far as the shareholders of company A are concerned, they still

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18.2 The UK reconstruction reliefs own a company carrying on the same business as before, they have not taken any money out of the corporate structure and nothing material has changed, but the capital gains legislation says that the shareholders have disposed of their shares in company A and received in consideration the shares in company B. Therefore, absent the exemption, the shareholders of company A would suffer a chargeable gain. Figure 18.1

Taking the same example, let us instead suppose that company A was not wound up, but the transfer of assets had been the consideration for a reduction of capital (as was intended in the Brooklands Selangor Holdings case – see Figure 18.2). So far as the shareholders of company A are concerned, they still own company A, as well as owning the shares in company B, which is carrying on the same business as company A did. This scenario suggests that there has not been a disposal as the shareholders of company A before are still the shareholders of company A afterwards, but the tax legislation refers to the transfer of assets by company A as a ‘capital distribution’ and capital distributions are treated as occasions of charge under capital gains tax. Therefore, again, absent the exemption, the shareholders of company A would suffer a chargeable gain even though they retain their shares in company A. Figure 18.2

Let us now look at the exemption for the shareholders in more detail.

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The UK reconstruction reliefs 18.4

TCGA 1992, S 136 – SCHEME OF RECONSTRUCTION INVOLVING ISSUE OF SECURITIES TCGA 1992, s 136(1) – application of provision 18.3 ‘(1) This section applies where – (a) an arrangement between a company (“company A”) and – (i)

the persons holding shares in or debentures of the company, or

(ii) where there are different classes of shares in or debentures of the company, the persons holding any class of those shares or debentures,

is entered into for the purposes of, or in connection with, a scheme of reconstruction; and

(b) under the arrangement – (i)

another company (“company B”) issues shares or debentures to those persons in respect of and in proportion to (or as nearly as may be in proportion to) their relevant holdings in company A, and

(ii) the shares in or debentures of company A comprised in relevant holdings are retained by those persons or are cancelled or otherwise extinguished.’ Analysis 18.4 This provision is straightforward. It requires an arrangement between a company and its shareholders or debenture holders, in connection with a scheme of reconstruction (which has the meaning given by TCGA 1992, Sch 5AA – TCGA 1992, s 136(4)(a)), whereby another company issues new shares or debentures to those shareholders or debenture holders pro rata to their holdings. There is also provision for the arrangements only to affect specific classes of share or debenture. This is generally familiar territory after our review of the definition of a scheme of reconstruction in TCGA 1992, Sch 5AA. This provision applies regardless of whether the originally held shares or debentures are retained or cancelled. The examples in the preamble to this analysis demonstrate these possible scenarios with company A being wound up in Figure 18.1, but with the shares in the transferor company being retained in Figure 18.2.

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18.5 The UK reconstruction reliefs Perhaps the most obvious difference in emphasis is that TCGA 1992, s 136 refers to shares and debentures, while TCGA 1992, Sch 5AA is only concerned with ordinary share capital. What this means is that to be a scheme of reconstruction, a scheme must comply with the requirements of TCGA 1992, Sch 5AA in respect of ordinary share capital. However, the scheme of reconstruction itself can go much wider and encompass the issue of any securities in respect of original holdings of any securities such as fixed-rate shares (that are not ordinary share capital by virtue of ICTA 1988, s 832(1)), loan notes and debentures or even interests in unit trusts (see the reference in TCGA 1992, Sch 5AA, para 8(1)(a)). Furthermore, the securities concerned need not be on a like-for-like basis. To comply with TCGA 1992, Sch 5AA, a scheme of reconstruction must have some ordinary share capital issued in respect of, and pro rata to, a holding of at least one class of ordinary share capital. Once that condition is satisfied, however, TCGA 1992, s 136 permits an issue of any type of share or debenture in respect of any type of security. So loan notes or fixed-rate preference shares might be issued in respect of holdings of ordinary share capital of a particular class, for example, or ordinary shares might be issued in respect of a holding of fixed-rate shares. Remember, however, that an issue of loan notes that are qualifying corporate bonds will invoke the hold-over provisions of TCGA 1992, s 116 described fully in Chapter 9. Note, also, that there is no requirement for the companies involved to be UK resident for tax purposes. The exemption relates to the tax charge on the shareholders and is not concerned with the residence status of the companies. TCGA 1992, s 136(2) – effect of provision 18.5 ‘(2) Where this section applies – (a) those persons are treated as exchanging their relevant holdings in company A for the shares or debentures held by them in consequence of the arrangement; and (b) sections 127 to 131 (share reorganisations, etc) shall apply with the necessary adaptations as if company A and company B were the same company and the exchange were a reorganisation of its share capital.

For this purpose shares in or debentures of company A comprised in relevant holdings that are retained are treated as if they had been cancelled and replaced by a new issue.’

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The UK reconstruction reliefs 18.8 Analysis 18.6 This provision is the actual exemption itself, ie if the conditions of subsection (1) are satisfied, the shareholders or debenture holders are treated, so far as possible, as if the transaction had been a reorganisation of share capital with company A and company B being the same company. To recap, TCGA 1992, s 127 treats the reorganisation as though there was no disposal and treats the newly acquired shares (or debentures) as being the same as the original holding of shares. Remember, this exemption is mandatory. If the conditions of TCGA 1992, s 136 are satisfied (subject to TCGA 1992, s 137 as well, see below and Chapter 13), then this exemption applies even if it is detrimental to the taxpayer. There is no discretion to disapply the exemption, except for a few specific provisions, such as TCGA 1992, ss 169Q and 169R where the taxpayer can elect for the reorganisation provisions not to apply. Let us look again at the examples: in Figure 18.1, as a result of TCGA 1992, s 136, the shareholders would not be treated as having made a disposal of the shares in or debentures of company A. Instead, the shares in or debentures of company B would be treated as being the same shares or debentures with the same base cost, period of ownership and so on. In Figure 18.2, the new holding would be the combined holdings in shares in or debentures of both companies A and B with the base cost apportioned between them appropriately. It is not immediately clear why any shares or debentures retained in the scheme of reconstruction are required to be treated as if they had been cancelled and reissued. Certainly, the definition of ‘new holding’ in TCGA 1992, s 126(1)(b) specifically includes any original shares still held as part of the new holding too. However, one of the ‘necessary adaptations’ referred to in TCGA 1992, s 136(2)(b) must be to permit the ‘original shares’ to include debentures, as the definition in TCGA 1992, s 126 only refers to shares. TCGA 1992, s 136(3) – preliminary reorganisations 18.7 ‘(3) Where a reorganisation of the share capital of company A is carried out for the purposes of the scheme of reconstruction, the provisions of subsections (1) and (2) apply in relation to the position after the reorganisation.’ Analysis 18.8 This provision is the same as TCGA 1992, Sch 5AA, para 6 and is intended to permit the necessary preliminary reorganisations to be made 369

18.9 The UK reconstruction reliefs without prejudice to the ability to satisfy the detailed requirements of TCGA 1992, s 136 itself. TCGA 1992, s 136(4) – definitions 18.9 ‘(4) In this section – (a) “scheme of reconstruction” has the meaning given by Schedule 5AA to this Act; (b) references to “relevant holdings” of shares in or debentures of company A are – (i)

where there is only one class of shares in or debentures of the company, to holdings of shares in or debentures of the company, and

(ii) where there are different classes of shares in or debentures of the company, to holdings of a class of shares or debentures that is involved in the scheme of reconstruction (within the meaning of paragraph 2 of Schedule 5AA); (c)

references to shares or debentures being retained include their being retained with altered rights or in an altered form, whether as a result of reduction, consolidation, division or otherwise; and

(d) any reference to a reorganisation of a company’s share capital is to a reorganisation within the meaning of section 126.’ Analysis 18.10

Most of this is self-explanatory or has already been discussed.

One area of concern, however, relates to the definition of ‘relevant holdings’. We are told that ‘relevant holdings’ means the shares or debentures held in company A, unless there is more than one class, in which case the relevant holding is the class ‘involved in the scheme of reconstruction’, a term defined in TCGA 1992, Sch 5AA, para 2. In the latter case, we look to TCGA 1992, Sch 5AA, para 2 where we note that the definition of a class ‘involved in the scheme of reconstruction’ is only given in terms of classes of shares, ie there is no definition of a class of debenture ‘involved in the scheme of reconstruction’. We assume that this lacuna in the legislation is an oversight on the part of the parliamentary draftsman and that TCGA 1992, s 136(4)(b)(ii) can be clearly understood by assuming a necessary adaptation and reading TCGA 1992, Sch 5AA, para 2 as if it also refers to debentures.

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The UK reconstruction reliefs 18.15 The reference to shares or debentures being retained in altered form permits a reorganisation of retained capital, again, without prejudice to the ability to satisfy the detailed requirements of the rest of TCGA 1992, s 136. TCGA 1992, s 136(5) – companies without share capital 18.11 ‘(5) This section applies in relation to a company that has no share capital as if references to shares in or debentures of the company included any interests in the company possessed by members of the company.’ Analysis 18.12 This provision has the same effect as TCGA 1992, s 135(5) and TCGA 1992, Sch 5AA, para 8(1)(b). TCGA 1992, s 136(6) – commerciality and fiscal test 18.13 ‘(6) This section has effect subject to section 137 (scheme of reconstruction must be for bona fide commercial reasons and not part of a tax avoidance scheme).’ Analysis 18.14 The application of TCGA 1992, s 137 and of clearances under TCGA 1992, s 138 is discussed in Chapters 13 and 14.

TCGA 1992, S 139 – COMPANY RECONSTRUCTION RELIEF Reason for the relief 18.15 This exemption applies to a company that, as part of a scheme of reconstruction, transfers its business, or part of its business, to another company for no consideration to the transferor company. We have seen such transfers in the cases we have reviewed in this Part. Clearly, this is a disposal of assets for the purposes of the taxation of chargeable gains. In the absence of an exemption for this form of transaction, there would be a disposal by the transferor company ‘otherwise than by way of a bargain made at arm’s length’ (TCGA 1992, s 17(1)(a)). As a result, TCGA 1992, s 17(1) would deem the disposal to be for an arm’s-length consideration, ie market value, with an appropriate chargeable gain being computed 371

18.16 The UK reconstruction reliefs accordingly. Therefore, in the absence of the exemption, companies would not be able to enter into schemes of reconstruction without incurring a substantial tax charge.

Company law issues 18.16 Before we look at the relief in detail, we should look briefly at the company law rules that permit a company to make such transfers of assets. A company’s directors have a fiduciary duty to act in the best interests of the company which is taken to mean the interests of the shareholders (both present and future) of the company, although if the company is insolvent or near to insolvency, the interests of the creditors of the company will prevail over the interests of the shareholders1. The fiduciary duties of the directors include a duty to take proper care of the assets of the company and so these fiduciary duties would not generally permit a company to give away its assets. Indeed, to act in a way that is detrimental to the interests of these shareholders and creditors can, in some instances, be unlawful. In addition, it is one of the most fundamental provisions of corporate law that a company shall maintain its capital and not give away assets other than out of distributable reserves or, provided that creditors will not be adversely prejudiced, by complying with the procedural requirements in CA 2006 (for example, a reduction of capital which is discussed in more detail in Chapter 25). There are, however, three relatively common ways in which a company can lawfully give away its assets (other than cash) for no consideration to a transferee company. These are: ●●

a distribution of assets in specie (out of distributable profits);

●●

a liquidation;

●●

a reduction of capital settled by a transfer of assets in specie.

A reduction of capital for a private limited company (unlike a public company) does not require court approval. CA 2006, s 641 only requires a statement of solvency to be signed by the directors (see Chapter 25), so a large number of transactions are now structured using capital reductions. Alternatively, a private limited company could re-register as an unlimited company and undertake a reduction of capital without having to seek court approval. However, this mechanism is rarely used in practice as unlimited companies place greater risk on their shareholders. All three of these mechanisms are commonly used to facilitate schemes of reconstruction. The second and third of these we have already seen in the transactions in the decided cases discussed earlier. These mechanisms 372

The UK reconstruction reliefs 18.17 are still used today for schemes of reconstruction, including demergers and amalgamations. The use of distributions in specie has been a common mechanism for demergers, in particular in recent years, since a special relief was enacted in 1980 to facilitate this way of partitioning business activities. This relief is now found in CTA 2010, Part 23, Chapter 5 and is discussed in detail in Chapter 24. We would mention briefly here the ability of a court to order the transfer of assets under CA 2006, s 900 too. But, as we shall see, this is not a common method of reconstruction or amalgamation, in our experience. Let us now move on to look at the exemption in TCGA 1992, s 139.

1 The general scope of directors’ fiduciary duties is beyond the ambit of this book. But Companies Act 2006 has codified those duties, as well as increasing them materially.

TCGA 1992, S 139 – RECONSTRUCTION INVOLVING TRANSFER OF BUSINESS TCGA 1992, s 139(1) – the basic relief 18.17 ‘(1) Subject to the provisions of this section, where – (a) any scheme of reconstruction involves the transfer of the whole or part of a company’s business to another company; and (b) the conditions in subsection (1A) below are met in relation to the assets included in the transfer; and (c)

the first-mentioned company receives no part of the consideration for the transfer (otherwise than by the other company taking over the whole or part of the liabilities of the business);

then, so far as relates to corporation tax on chargeable gains, the two companies shall be treated as if any assets included in the transfer were acquired by the one company from the other company for a consideration of such amount as would secure that on the disposal by way of transfer neither a gain nor a loss would accrue to the company making the disposal, and for the purposes of Schedule 2 [assets held on 6 April 1965] the acquiring company shall be treated as if the respective acquisitions of the assets by the other company had been the acquiring company’s acquisition of them.’

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18.18 The UK reconstruction reliefs Analysis 18.18 TCGA 1992, s 139(1) has existed in substantially unchanged form since its introduction as FA 1962, Sch 9, para 13(1) and re-enactment in identical form as FA 1965, Sch 7, para 7(2) as part of the introduction of corporation tax and capital gains tax. It is interesting to note that the headers for both early provisions are ‘Company amalgamations’ given that even the first cases in this area, the Western Counties and South Wales Telephone and the South African Supply and Cold Storage cases, were concerned with reconstructions, rather than amalgamations (although the latter case also had an amalgamation). However, as pointed out previously, the headers have no statutory force, so nothing rides on this issue. The first part of TCGA 1992, s 139(1) sets out the conditions required for the exemption to apply. The main requirement is that there be a transfer of a business or part of a business for no consideration from the perspective of the transferring company, except for taking on any of the debts of that business. The HMRC Capital Gains Manual has some helpful comments on the meaning of ‘business’ at CG52709, as discussed in Chapter 16. The Manual notes that whether a company or companies carry on a business is a question of fact. However, there is a useful example of a company with an investment business. The example clearly implies that the mere holding of investments does not constitute a business; there must be a requirement to manage the investments too. So, taking the example given, if the reconstruction transferred the investments to a successor company leaving the investment management business with the original company, the successor company would not be carrying on a business at all, so the tests at TCGA 1992, Sch 5AA, para 4(1)(a)(ii) or (b)(ii) may not be satisfied and the scheme would not be a scheme of reconstruction. The use of the word ‘business’ is also important as a contrast to the use of the word ‘trade’ in other contexts, particularly CTA 2010, Part 23, Chapter 5 in relation to demergers, as we shall see in Chapter 24. So the relief under TCGA 1992, s 139 is not restricted to trade transfers and can be used for the demerger of businesses that are not trades as well as trading businesses. This is entirely consistent with other tax legislation relating to schemes of reconstruction. At first glance, the use of the words ‘the whole or part of a company’s business’ does not seem to encompass the transfer of group subsidiaries as part of a scheme of reconstruction. However, HMRC has always accepted that the holding of subsidiaries is a business for the purposes of this legislation, so the relief is available for the transfer of subsidiaries in a reconstruction, as well

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The UK reconstruction reliefs 18.18 as for the transfer of businesses per se. This may be a direct application of the dictum from the Privy Council case of American Leaf Blending Co Sdn Bhd v Director-General of Inland Revenue [1978] STC 561, where Lord Diplock said that ‘in the case of a company incorporated for the purpose of making profits for its shareholders any gainful use to which it puts any of its assets prima facie amounts to the carrying on of a business’. One area of interpretation that has caused difficulty is that HMRC used to take the view that ‘a company’s business’ means a business (or subsidiary) that is at least 75 per cent owned by the transferor company, although there is nothing in the statute to support this interpretation. More recently, however, our experience is that HMRC will now accept that the relief is capable of applying to a transfer of a business or subsidiary that is less than 75 per cent owned. Note, however, that the 75 per cent requirement is a statutory test for the purposes of exempt distribution demergers (see Chapter 24). The business or part business must also be transferred for no consideration from the perspective of the transferor company. This is qualified somewhat to allow the transferee company to take on ‘the whole or part of the liabilities of the business’. Without this proviso, taking on debt or other liabilities of a business might be seen as consideration given to the transferor company, so that the relief could not apply and the transfer would be taxable as a non-arm’s length disposal. But this may also be seen as a ‘belt and braces’ approach by the draftsman, as transferring a business activity could also be interpreted as necessarily including the transfer of the liabilities of that business, as well as its assets, at least from a commercial perspective. See also TCGA 1992, s 139(1B) at 18.22, below. The second part of TCGA 1992, s 139(1) tells us that a transfer of a business or part of a business, as part of a scheme of reconstruction, will be treated for tax purposes as having taken place at a consideration that would generate no gain and no loss on the disposal. This means that the transferee company ‘inherits’ the base cost (with indexation, if appropriate, to 31 December 2017, which is the date that indexation for companies was frozen) of the assets transferred to it in the scheme of reconstruction. On any future disposal of those assets outside that company (or the group of which it is a member), the full gain (or loss) in respect of that disposal will accrue. Thus the assets transferred in Figures 18.1 and 18.2 are assumed to have the same base cost in B as they had in A. This was part of the undertaking signed by the directors in the Morgan’s Executors case. Readers will recall that a concessionary treatment was granted under the terms of the Revenue’s Statement D14 so long as the transferee companies, Locks and Pressings, gave an undertaking that the tax

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18.19 The UK reconstruction reliefs consequences of this treatment would apply to those companies on the basis that the transactions in that case did not, as a matter of company law, amount to a scheme of reconstruction. This relief, like that at TCGA 1992, s 136, is mandatory. If the conditions of TCGA 1992, s 139 are satisfied, the relief applies even if it is detrimental to the taxpayer. There is no scope to disapply the provisions of TCGA 1992, s 139(1) and accept the tax charge (or, more likely, to try and crystallise an allowable loss). It is interesting to note that TCGA 1992, s 139 is silent as to whether the transferee company should issue shares to the shareholders of the transferor company. In recent years, the transferee company will invariably issue shares to the shareholders of the transferor by way of consideration. This is because, although an issue of shares is not a requirement for the purposes of TCGA 1992, s 139, it is a requirement of TCGA 1992, Sch 5AA for the transaction to be a scheme of reconstruction, as we have already seen. Interaction with the substantial shareholding exemption 18.19 Since the introduction of the substantial shareholding exemption by FA 2002, it might appear that TCGA 1992, s 139 would be less relevant to groups where the business transferred comprises the shares of a trading subsidiary or the holding company of a trading sub-group. However, TCGA 1992, Sch 7AC, para 6(1)(a) specifically removes all ‘no gain no loss’ disposals from the scope of the substantial shareholding exemption. This might initially seem counterintuitive, but there are some good reasons for this approach: ●●

to allow the substantial shareholding exemption to apply where a trading group undergoes a reconstruction involving the transfer of a trading subsidiary or sub-group would be to treat reconstructions of trades differently from reconstructions of other businesses (and, indeed, would be to treat reconstructions involving the transfer of a trading subsidiary or sub-group differently from a reconstruction involving the transfer of a trade directly);

●●

the policy behind the taxation of reconstructions has always been that they should effectively not be taxable events. To permit the substantial shareholding exemption to apply in a reconstruction of a trading group would, therefore, have the effect of overriding this policy and doing so in an inconsistent way as this differential treatment would only apply to a reconstruction involving the transfer of a trading subsidiary or sub-group;

●●

finally, if the substantial shareholding exemption were to apply in a reconstruction of a trading group, this would generate a disposal, albeit an exempt disposal, so that the transferee company gets the advantage of 376

The UK reconstruction reliefs 18.21 an open market value base cost of the shares in respect of any subsequent disposal to which the substantial shareholding exemption may not apply. So there would be a specific and unwarranted advantage that applies only to trading groups and only in schemes of reconstruction involving the transfer of a trading subsidiary or sub-group. In summary, therefore, if the substantial shareholding exemption could apply to these transactions, there would not only be inconsistency between schemes of reconstruction involving trading groups and those involving groups with non-trading businesses, the inconsistency would also be between schemes of reconstruction that involved a transfer of trades (ie of assets) and those involving transfers of shares in subsidiaries. So there are strong policy reasons to ensure that transactions to which relief under TCGA 1992, s 139 applies are outside the scope of the substantial shareholding exemption. For a more detailed discussion of the substantial shareholding exemption and the interaction with the reorganisation rules, see Chapter 11. TCGA 1992, s 139(1A) – scope of the relief 18.20 ‘(1A) The conditions referred to in subsection (1)(b) above are – (a) that the company acquiring the assets is resident in the United Kingdom at the time of the acquisition, or the assets are chargeable assets in relation to that company immediately after that time; and (b) that the company from which the assets are acquired is resident in the United Kingdom at the time of the acquisition, or the assets are chargeable assets in relation to that company immediately before that time.

For this purpose an asset is a “chargeable asset” in relation to a company at any time if, were the asset to be disposed of by the company at that time, any gain accruing to the company would be a chargeable gain and would by virtue of section 10B form part of its chargeable profits for corporation tax purposes.’

Analysis 18.21 When originally enacted, the relief was not restricted to UK tax resident companies. This restriction was added by FA 1968, Sch 12, para 15(2) such that both the transferor and transferee companies had to be resident in the UK for all transfers after 10 April 1968. The restriction was partly removed by FA 2000 to allow the relief to apply to transfers of the business of the UK branch of a non-UK company or the transfer of a business of a UK company to a UK branch of a non-UK company by inserting the references 377

18.22 The UK reconstruction reliefs to chargeable assets. Whilst, legally, a UK branch of a company is not a legal entity and any transfer of a branch is a transfer by the company of its assets, those assets will be chargeable assets for the purposes of UK tax on chargeable gains. This requirement is specific to TCGA 1992, s 139, as we have already seen that there are no equivalent requirements in TCGA 1992, Sch 5AA or TCGA 1992, s 136. However, in those provisions, the residence of the company is not relevant as, for example, in TCGA 1992, s 136 it is the tax position of the shareholder that is in point. In the case of the company level relief, without this provision, the transferee company could be non-UK resident and the effect of the scheme of reconstruction would be to take the assets outside the UK tax net. At first glance, it is not clear why the transferor company has to be UK resident. In such a case, the UK’s exemption from tax on the transfer would be meaningless as the transferor company would be outside the scope of UK taxation anyway. It is also interesting to ponder whether the provision is consistent with EU anti-discrimination law particularly relating to the free movement of capital or freedom of establishment. That said, most of the potential issues will have been resolved by the complete enactment into UK tax law of the EU Mergers Directive1 (see, in particular, Chapters 4, 19 and 20).

1 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005).

TCGA 1992, s 139(1B) – interaction with capital gains degrouping charge 18.22 ‘(1B) Nothing in section 179(3D) prevents the two companies being treated as mentioned in subsection (1).’ Analysis 18.23 The changes in FA 2011 to the capital gains degrouping charge, referred to in Chapter 1, introduced a new complication in respect of the reconstruction exchange rules. Consider the following position (Figure 18.3).

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The UK reconstruction reliefs 18.23 Figure 18.3 Reconstructions and degrouping

When Company B leaves Company A’s group, it is holding an asset which was transferred to it by Company A less than six years earlier. So there is a degrouping event, as defined by TCGA 1992, s 179, as a result of a group disposal (the disposal by Company A of Company B). Under the rules explained in Chapter 1 (see 1.10), the gain on the deemed disposal and reacquisition of the asset by Company B is to be added to the consideration received by Company A for selling Company B (TCGA 1992, s 179(3D)). However, under TCGA 1992, s 139(1)(c), Company A must not receive any consideration for the disposal of Company B, otherwise the no gain, no loss treatment of TCGA 1992, s 139(1) cannot apply. So this provision makes sure that the deemed consideration required by TCGA 1992, s 179(3D) does not prevent TCGA 1992, s 139(1) from applying in the normal way, even if there is an associated degrouping event. Apart from TCGA 1992, s 139(1B), there is nothing in either the reconstruction rules or the degrouping rules about what happens to the degrouping charge in these circumstances. The legislation suggests that it should still fall on Company A, as that is the normal rule in these circumstances, so that there is a tax-free reconstruction but Company A still suffers tax on the degrouping. However, HMRC has stated in correspondence that, in the circumstances of Figure 18.3, for example, the degrouping charge just disappears. It doesn’t fall on Company A and it is not held over until some later event. HMRC has subsequently stated that its view on this point is explained at CG45420, under the heading ‘Other consequences’, although this is not immediately clear to the authors! While this might appear to be a potentially useful tax planning opportunity, readers are reminded that TCGA 1992, s 139(1) only applies if the reconstruction 379

18.24 The UK reconstruction reliefs is not part of a scheme where one of the main purposes is the avoidance of corporation tax (see TCGA 1992, s 139(5) below), so clearance might be refused if a scheme of reconstruction were seen by HMRC as being intended to achieve a tax-free degrouping using this mechanism. Note also that there was no equivalent to these rules in the provisions for the degrouping of intangible fixed assets. Until 7 November 2018, if the asset concerned was, say, goodwill in a post-1 April 2002 trade, there was no protection from the degrouping charge in CTA 2009, s 780 (see 18.32 et seq). For degrouping events on or after that date, CTA 2009, s 782A (introduced by FA 2019) simply disapplies the degrouping charge for chargeable intangible assets in most cases. TCGA 1992, s 139(2) to (4) – exclusions from relief 18.24 ‘(2) This section does not apply in relation to an asset which, until the transfer, formed part of trading stock of a trade carried on by the company making the disposal, or in relation to an asset which is acquired as trading stock for the purposes of a trade carried on by the company acquiring the asset.

Section 170(1) applies for the purposes of this subsection.

(3) [Repealed] (4) This section does not apply in the case of a transfer of the whole or part of a company’s business to a unit trust scheme to which section 100(2) applies or which is an authorised unit trust or to an investment trust or a venture capital trust.’ Analysis 18.25 TCGA 1992, s 139(2) ensures that the relief does not apply to assets that are trading stock rather than chargeable assets within the chargeable gain regime in the hands of either the transferor or transferee company. The words ‘profits’ and ‘trade’ have the meanings given by TCGA 1992, s 170(1). Given that the chargeable gains regime necessarily only applies to chargeable assets, in any case, TCGA 1992, s 139(2) appears to be otiose. TCGA 1992, s 139(4) has a similar effect in that it removes the relief from transactions whereby assets are transferred to certain types of exempt body, specifically authorised unit trusts, approved investment trusts and venture capital trusts. This prevents avoidance whereby the assets are transferred tax-free to an entity in whose hands the eventual disposal would be exempt, thereby avoiding any tax on the chargeable gain.

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The UK reconstruction reliefs 18.28 TCGA 1992, s 139(5) – pre-transaction clearances 18.26 ‘(5) This section does not apply unless the reconstruction is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to corporation tax, capital gains tax or income tax; but the foregoing provisions of this subsection shall not affect the operation of this section in any case where, before the transfer, the Board have, on the application of the acquiring company, notified the company that the Board are satisfied that the reconstruction will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as aforesaid.

Subsections (2) to (5) of section 138 shall have effect in relation to this subsection as they have effect in relation to subsection (1) of that section.’

Analysis 18.27 As with the reorganisation and reconstruction reliefs we have seen earlier in this book, relief under TCGA 1992, s 139 is not available if the transaction fails either the bona fide commercial reasons or the tax avoidance tests. Unlike the requirements in TCGA 1992, s 137(1), however, where tax avoidance refers only to capital gains tax and corporation tax, TCGA 1992, s 139(5) also refers to avoidance of income tax. Again, as for TCGA 1992, ss 135 and 136, a pre-transaction clearance is available and TCGA 1992, s 138(2)–(5) applies to clearances under TCGA 1992, s 139 as to TCGA 1992, ss 135 and 136 (see Chapter 13). Note that it is the transferee company that applies for the clearance, not the transferor, even though it is the transferor that would otherwise suffer a tax charge on the disposal. In practice, we have never seen HMRC refuse to consider an application made by the ‘wrong’ company for capital gains purposes. However, see 18.42 regarding clearances relating to chargeable intangible assets. TCGA 1992, s 139(6) and (7) – collection of unpaid tax 18.28 ‘(6) Where, if the company making the disposal had not been wound up, tax could have been assessed on it by virtue of subsection (5) above, that tax may be assessed and charged (in the name of the company making the disposal) on the company to which the disposal is made. (7) If any tax assessed on a company (“the chargeable company”) by virtue of subsection (5) or (6) above is not paid within 6 months from the date 381

18.29 The UK reconstruction reliefs [when it is due and payable or, if later, the date when the assessment is made on the company], any other person who – (a) holds all or any part of the assets in respect of which the tax is charged; and (b) either is the company to which the disposal was made or has acquired the assets without there having been any subsequent disposal not falling within this section or section 171;

may, within 2 years from the later of those dates, be assessed and charged (in the name of the chargeable company) to all or, as the case may be, a corresponding part of the unpaid tax; and a person paying any amount of tax under this section shall be entitled to recover from the chargeable company a sum equal to that amount together with any interest paid by him under section 87A of the Management Act on that amount.

(8) [Repealed]’ Analysis 18.29 This is simply a collection mechanism to prevent a company transferring its business under TCGA 1992, s 139 and winding up without paying any tax due. It only applies where TCGA 1992, s 139(5) is in point, ie where the transfer was not for bona fide commercial reasons or was for the avoidance of tax. The original version of these rules was enacted as FA 1977, s 41, effective from 19 April 1977, at the same time as TCGA 1992, s 139(5), and the Hansard record (cols 954–956) reflects the fact that this was intended as a tax recovery method where tax could not be recovered from the transferor company. The provisions apply where a transferor company has been wound up, presumably because otherwise the company would still exist and be assessable. TCGA 1992, s 139(6) allows the assessable and chargeable tax to be assessed and charged on the transferee company instead. If the tax assessed is not paid within six months of the assessment, HMRC can reclaim tax from any other person who holds any of the assets in respect of the disposal of which the tax is charged in so far as that person has not acquired those assets through any normal disposal from the transferor company. However, the amount of tax that can be recovered from another party this way is restricted to ‘a corresponding part of the unpaid tax’, which is assumed to mean a part of the tax relating to the proportion of the assets transferred to that person. Any such person is then entitled to try and recover both the tax and any interest charged from the chargeable company, ie the company originally chargeable under TCGA 1992, s 139(6).

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The UK reconstruction reliefs 18.32 TCGA 1992, s 139(9) – definition 18.30 ‘(9) In this section “scheme of reconstruction” has the same meaning as in section 136.’ Analysis 18.31 This just ensures that it is clear that the definition follows TCGA 1992, Sch 5AA.

RECONSTRUCTIONS AND INTANGIBLE FIXED ASSETS – CTA 2009, PART 8 18.32 As noted in the Introduction to the Second Edition, there are now effectively separate tax regimes for other classes of asset that might previously have been chargeable assets, within the charge to tax on chargeable gains. One of these is the regime for intangible fixed assets in CTA 2009, Part 8 which contains a provision equivalent to TCGA 1992, s 139. CTA 2009, s 906(1) reads: ‘The amounts to be brought into account in accordance with this Part in respect of any matter are the only amounts to be brought into account for corporation tax purposes in respect of that matter’. It therefore takes intangible fixed assets completely outside the scope of taxation of chargeable gains legislation. The new regime only applies, however, to ‘new assets’ defined (by CTA 2009, s 882 et seq) as assets that have been created or acquired by the taxpayer company on or after 1 April 2002. Such assets are called ‘chargeable intangible assets’ being assets to which the new regime applies. Where a reconstruction proceeds by the transfer of a business (ie not a subsidiary) to a transferee company, the intangible fixed assets of that business should therefore be dealt with under CTA 2009, Part 8 so long as they were created or acquired by the transferee company on or after 1 April 2002 or qualify under the revised commencement rules brought in by FA 2020 and applicable to acquisitions from related parties on or after 1 July 2020. There are no specific transitional provisions, for example, where the assets transferred by the transferor company are within the chargeable gains regime, but the same assets will be within the intangible fixed asset regime as chargeable intangible assets of the transferee company. In the absence of such provisions, we offer our interpretation of the interaction of these regimes later in this chapter. The basic provisions are at CTA 2009, s 818. 383

18.33 The UK reconstruction reliefs

CTA 2009, s 818 – company reconstruction involving transfer of business CTA 2009, s 818(1) and (6) – the basic relief 18.33 ‘(1) This section applies if – (a) a scheme of reconstruction involves the transfer of the whole or part of the business of one company (“the transferor”) to another company (“the transferee”); and (b) the transferor receives no part of the consideration for the transfer (otherwise than by the transferee taking over the whole or part of the liabilities of the business).

But see subsections (3) to (5).

(6) In this section “scheme of reconstruction” has the same meaning as it has in section 136 of TCGA.’ Analysis 18.34 This provision is almost identical to TCGA 1992, s 139(1) in its terms. So the requirement is a scheme of reconstruction as part of which a business is transferred from a transferor company to a transferee company and the transferor company receives no consideration for the transfer of the assets of the business, except the transferee taking over the appropriate liabilities of the business transferred. Again, we are referred to the TCGA 1992, s 136 definition of a reconstruction, ie one that fulfils the conditions of TCGA 1992, Sch 5AA. TCGA 1992, s 818(2) – scope of the relief 18.35 ‘(2) If the transfer includes intangible fixed assets that – (a) are chargeable intangible assets in relation to the transferor immediately before the transfer, and (b) are chargeable intangible assets in relation to the transferee immediately after the transfer,

the transfer of those assets is tax-neutral for the purposes of this Part.’

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The UK reconstruction reliefs 18.38 Analysis 18.36 The main effect of this provision is to impose tax neutrality on a business transfer to which CTA 2009, s 818(1) applies. Tax neutrality means that the transfer is deemed not to be a realisation (ie disposal) or acquisition and anything done by the transferor while owning the asset is deemed to have been done by the transferee (CTA 2009, s 776). In particular, the transferee is deemed to have acquired the asset at the same original cost as the transferor had and to have brought into account all the transferor’s debits and credits in respect of that asset (CTA 2009, s 776(2)). CTA 2009, s 818(2) also ensures that the relief only applies where the assets concerned are chargeable intangible assets to the transferor before the transfer and to the transferee afterwards. ‘Chargeable intangible asset’ is defined at CTA 2009, s 741(1). Broadly, this means an asset the disposal of which would be brought into account as a realisation of an intangible fixed asset. This has much the same effect as CTA 2009, s 139(1A), in that an intangible fixed asset can only be a chargeable intangible asset of a company if that company is either UK resident for tax purposes or if the assets are the assets of a UK branch business of a non-UK company. Thus, insofar as the assets transferred in Figures 18.1 and 18.2 were chargeable intangible assets, the transfer to B is tax neutral so that B inherits the tax history of those assets in the hands of A. Another effect of this provision is that the relief cannot apply if the asset transferred by the transferor company is not an asset within CTA 2009, Part 8, perhaps because it is a pre-commencement asset dealt with under the chargeable gains regime. This is because the asset must be a chargeable intangible asset in respect of both companies. The effect of a transfer where the asset is not a chargeable intangible asset of the transferor is discussed in more detail below. CTA 2009, s 818(3) – interaction with other provisions 18.37 ‘(3) This section does not apply if the transfer is one to which section 775 (transfers within a group) applies.’ Analysis 18.38 This provision ensures that there is no conflict between the reconstruction rule and the rule for tax neutral transfers within a group of

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18.39 The UK reconstruction reliefs companies. The latter takes priority, although the effect is the same, that the transfer will be tax neutral. This is similar to the interaction of CTA 2009, ss 139 and 171, where reconstruction transfers and intra-group transfers are both deemed to be at no gain and no loss, although the rules for chargeable gains are not prioritised in CTA 2009, s 139. So why the formal prioritising in CTA 2009, Part 8? This is frankly not clear to us. The only effect we can see is that if an intra-group transfer is also a scheme of reconstruction, no clearance application is required to be sure of the tax neutral treatment. But the same might be said of the chargeable gains rules, which are not similarly prioritised. CTA 2009, s 818(4) – exclusions from relief 18.39 ‘(4) This section does not apply if the transferor or the transferee is – (a) a qualifying society within the meaning of section 461A of ICTA (incorporated friendly societies entitled to exemption from tax); or (b) a dual resident investing company within the meaning of section 949 of CTA 2010 (dual resident investing companies).’ Analysis 18.40 This is similar in nature to CTA 2009, s 139(4), although the exclusions are different. The CTA 2009, s 139 exclusion for unit trusts, etc would not need to apply to CTA 2009, Part 8 as unit trusts and similar bodies only own shares, so a regime applying only to intangible fixed assets, like CTA 2009, Part 8, would not need to consider asset transfers to such bodies. It is less clear, however, what policy reasons there are to exclude qualifying friendly societies and dual resident investment companies from the reconstruction relief for intangible assets but not from the reconstruction relief for tangible assets. CTA 2009, s 818(5) – motive test and clearances 18.41 ‘(5) This section applies only if the reconstruction meets the genuine commercial transaction requirement (see section 831).’ Analysis 18.42 This is self-explanatory. CTA 2009, s 831 imports a requirement for transactions to have been carried out for genuine commercial reasons and 386

The UK reconstruction reliefs 18.43 not as part of a scheme or arrangements for the avoidance of corporation tax, capital gains tax or income tax, which is very similar to TCGA 1992, s 139(5). The procedures for clearance, at CTA 2009, ss 832 and 833, are very similar in operation to TCGA 1992, s 138, as discussed in Chapter 14. One problem we have is that CTA 2009, s 831(2)(a) and (3)(a) have the effect that the application must be made by the transferee company, as is the case for TCGA 1992, s 139(5) clearances. However, the team in technical charge of the intangibles regime, who deal with these applications (see 14.18), apply this rule strictly, and refuse to consider clearance applications unless they are made by or on behalf of the right company. The practical issue, of course, is that the transferee company is usually not formed when the clearance application is made, because that might be a waste of time if clearance is not granted. Nevertheless, the intangibles clearance team refuse to take the sensible, pragmatic approach adopted by their capital gains tax colleagues, so we are forced to incorporate a potentially unnecessary company in advance of applying for clearances under these provisions. The sensible thing to do, of course, would be to amend the legislation so that applications for clearance under TCGA 1992, s 139(5) and CTA 2009, s 831 can be made by the transferor company, too.

INTERACTION OF CTA 2009, PART 8 WITH CHARGEABLE GAINS PROVISIONS 18.43 As we have seen above, there are self-contained provisions for the treatment of capital gains assets on a reconstruction transfer and for intangible fixed assets on a transfer in a reconstruction, but what happens where a reconstruction occurs and old, pre-commencement intangible assets are transferred as part of the business to a company in whose hands they are assets that are to be dealt with under CTA 2009, Part 8 as chargeable intangible assets1? From the perspective of the transferor company, this is quite straightforward, assuming a bona fide commercial purpose for the transaction. TCGA 1992, s 139 applies to deem the disposal by the transferor company to be at no gain and no loss. However, if the asset concerned is a chargeable intangible asset of the transferee company, TCGA 1992, s 139 only applies for the purposes of the chargeable gains arising on the transferor company. For the transferee company, there is no specific legislation to tell us what the ‘amount of expenditure on the asset 387

18.44 The UK reconstruction reliefs that it recognised for tax purposes’ of the newly acquired intangible fixed asset should be. However, CTA 2009, s 729(4) defines ‘the amount of expenditure on the asset that it recognised for tax purposes’ as being ‘the same as the amount of any expenditure on the asset capitalised by the company’. The operation of CTA 2009, Part 8 is based on generally accepted accounting principles, so the amount capitalised by the company will be based on either UK GAAP or IAS. So the logical answer appears to be that the tax cost of an asset that is a chargeable intangible asset of a company as a result of a scheme of reconstruction will be the amount capitalised in the balance sheet under UK GAAP or IAS, although this doesn’t sit easily with a general policy of a no gain, no loss or tax neutral transfer.

1 We believe this is likely to be a rare event as the intangible asset rules are wide-ranging in preventing transfers between ‘related parties’ turning ‘old assets’ into new chargeable intangible assets. In most schemes of reconstruction, it is likely therefore that the transferor is a related party of the transferee company. The analysis is outside the scope of this book.

CONCLUSION 18.44 Having reviewed the definition of a scheme of reconstruction in Chapter 16, along with the history of that definition, in this chapter we have reviewed the reliefs from tax designed to facilitate schemes of reconstruction. Both these reliefs, TCGA 1992, ss 136 and 139, have been around since the days of the short-term gains legislation of 1962, and, while they operate differently, they have the same effect, of preserving the asset level base cost and hence ensuring that the full gain comes into charge when the asset – whether it be the shareholders’ shares or the company’s assets – is eventually sold. Both reliefs have been adapted with changing circumstances, to the full capital gains tax code, then as that code has itself changed. More interesting, perhaps, is the way that the company level relief, TCGA 1992, s 139, has been adapted in almost exactly the same form to encompass the more recent system for the taxation of intangible fixed assets, as described in this chapter. Having now reviewed what a transaction is in tax terms, and how the main reliefs work, let’s look at particular types of transaction to which these reliefs are frequently applied: mergers and demergers.

STAMP TAXES 18.45 The reliefs from stamp taxes arising on transfers of assets in the course of a ‘reconstruction’, are explained in Chapter 2. It is noted as well

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The UK reconstruction reliefs 18.46 that the conditions for these reliefs are more stringent than under TCGA 1992, ss 136 and 139.

VALUE ADDED TAX 18.46 The VAT implications of the various ways in which reconstructions can be carried out are considered in the appropriate chapters.

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Part 5

Mergers

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Chapter 19

UK company mergers

SCOPE OF THIS CHAPTER 19.1 As briefly explored in 17.5, Companies Act 2006, s 900 in its simplest form establishes the foundations for a domestic merger regime for UK companies only by way of a court-approved scheme of arrangement. Furthermore, CA 2006, Part 27 implements the Consolidating Directive1 and imposes additional requirements where UK public companies are undertaking a merger under CA 2006, Part 27. As such, in this chapter, we will firstly look at mergers of UK companies, before moving on to cross-border mergers within the EU.

1 Directive 2017/1132/EU of the European Parliament and of the Council of 14 June 2017 relating to certain aspects of company law codification (and which repeals the First Company Law Directive (Codified), Second Company Law Directive (Recast), Third Company Law Directive (Codified), Sixth Company Law Directive, Eleventh Company Law Directive and Cross Border Mergers Directive).

LEGAL CONSIDERATIONS What is a merger? 19.2 In order to consider the tax consequences of a merger, we should first understand its meaning from an English company law perspective. The term ‘merger’ has already been defined in 4.7 by reference to the Consolidating Directive and it is this definition that has been used throughout the chapters in this book. However, English company law has adopted a different definition contained in CA 2006, Part 27 (insofar as it applies to public companies), a comparison of which is set out for ease in the table below:

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19.2 UK company mergers Mergers of public limited liability companies Consolidating Directive Part 27 of the CA 2006 Article 89: Definition of a Section 902: Application of this Part ‘merger by acquisition’ (1) This Part applies where– ‘Merger by acquisition’ (a) a compromise or arrangement shall mean the operation is proposed between a public whereby one or more company and– companies are wound (i) its creditors or any class of up without going into them, or liquidation and transfer (ii) its members or any class of to another all their them, assets and liabilities in exchange for the issue to for the purposes of, or in the shareholders of the connection with, a scheme for the company or companies reconstruction of any company or being acquired of shares companies or the amalgamation of in the acquiring company any two or more companies, and a cash payment, if any, (b) the scheme involves– not exceeding 10 % of the (i) a merger (as defined in nominal value of the shares section 904), or so issued or, where they have no nominal value, of (ii) a division (as defined in their accounting par value. section 919), and (c) t he consideration for the transfer Article 90: Definition of a (or each of the transfers) ‘merger by the formation envisaged is to be shares in the of a new company’ transferee company (or one or ‘Merger by the formation more of the transferee companies) of a new company’ shall receivable by members of the mean the operation transferor company (or transferor whereby several companies companies), with or without any are wound up without cash payment to members. going into liquidation and transfer to a company Section 904: Mergers and merging companies that they set up all their (1) The scheme involves a merger where assets and liabilities in under the scheme– exchange for the issue (a) the undertaking, property and to their shareholders of liabilities of one or more public shares in the new company companies, including the company and a cash payment, if any, in respect of which the compromise not exceeding 10 % of the or arrangement is proposed, are to nominal value of the shares be transferred to another existing so issued or, where they public company (a “merger by have no nominal value, of absorption”), or their accounting par value. 394

UK company mergers 19.3 Mergers of public limited liability companies Consolidating Directive Part 27 of the CA 2006 (b) the undertaking, property and liabilities of two or more public companies, including the company in respect of which the compromise or arrangement is proposed, are to be transferred to a new company, whether or not a public company, (a “merger by formation of a new company”). (2) References in this Part to “the merging companies” are– (a) in relation to a merger by absorption, to the transferor and transferee companies; (b) in relation to a merger by formation of a new company, to the transferor companies. To summarise, from an English company law perspective, a ‘merger’ (whether for private or public companies) may only take place where it involves a scheme for the ‘amalgamation’ of any two or more companies for the purpose of CA 2006, s 900. The term ‘amalgamation’ is not defined in the CA 2006; however, judicial consideration of this term to fill in gaps in its statutory context provides some guidance as to how the English courts are likely to construe an amalgamation under CA 2006, s 900. In this regard, the fundamental features of a ‘merger’ (or in this context, ‘amalgamation’) can be divided in three parts.

First feature: business combination of merging companies 19.3 The classic definition of an ‘amalgamation’ is contained in Re South African Supply and Cold Storage Co [1904] 2 Ch 268 (at page 287) and involves the rolling of two (or more) concerns into one, ie the blending of the undertakings of two (or more) existing companies into one company, with the shareholders of each company becoming the shareholders in the surviving company, which holds the blended undertakings. The court held that an amalgamation could be achieved (i) by the transfer of the undertakings of companies A and B to a new company C; or (ii) by the transfer of the undertakings of companies A and B to be continued by existing company B.

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19.4 UK company mergers As such, the first feature of a merger must be that the business assets and liabilities of two or more existing companies are combined, so that the combined business assets and liabilities are continued by and vested in one successor company. However, this can arguably be achieved merely by one company buying the business assets and liabilities of another company, so there must be something more to it than that. This point was considered in detail in the case of Swithland Investments Ltd and another v Inland Revenue Commissioners [1990] STC 448 (at page 464), where the court applied the ‘amalgamation’ definition from the Re South African Supply case to a series of transactions involving share transfers and share exchanges to effect a corporate reorganisation, in order to determine whether an amalgamation had occurred. The court held that the mere purchase of shares in one company by another did not bring about an amalgamation of the companies or of its undertakings, and that there had been no coming together of two companies, nor any welding or blending of two undertakings into one. In the case of Re Walker’s Settlement, Royal Exchange Assurance Corporation v Walker [1935] Ch 567, the courts went further (at page 585) to state that the purchase of shares may be a step towards amalgamation, but that an amalgamation would, in such a case, eventually be brought about by the transferor company being put into liquidation by the transferee company (which has bought its shares) and the undertaking of the transferor company having been acquired by the transferee company.

Second feature: dissolution 19.4 This brings us to the second distinguishing feature of a merger: a merger typically requires there to be fewer companies after the transaction than there were before and, based on English case law, is a factor the English courts will consider when determining whether a merger has taken place. This also accords with the way a ‘merger’ has been defined in the Consolidating Directive (see above) and the Companies (Cross-Border Merger) Regulations 2007 (SI 2007/2974) (which are further discussed in Chapter 20), the effect of which would result in one or more transferor companies being dissolved without going into liquidation.

Third feature: consideration 19.5 The third feature of a merger, unlike an acquisition, is that there is generally no cash consideration. The consideration is wholly or mainly in the form of an issue of shares by the transferee company to the shareholders of the transferor companies. The Consolidating Directive specifically limits any cash payment to 10 per cent of the nominal value of the shares issued, whereas a domestic merger involving public companies under CA 2006, Part 27 does 396

UK company mergers 19.6 not technically contain such a cash payment restriction. This is different from a domestic merger involving private companies only under CA 2006, s 900 which is silent on the form of consideration that may be provided and does not require an issue of shares but merely permits the court order to make provision for such an issue. However, in order for the transaction to be construed as a merger construct and not an acquisition construct, the English courts will likely want to see consideration being largely in the form of shares. That being said, the transactions in the Re South African Supply case did involve a mix of cash payments and an issue of shares. But these transactions were carried out in a very different legal environment. In summary, for there to be a true merger of two companies, there can only be one successor company which holds the combined business assets and liabilities of the transferor companies, and the shareholders of the successor company must substantially consist of the shareholders of the original merging companies. This can be compared with our view of demergers (see Chapter 21 et seq). While a demerger involves splitting up a group or business without a sale, so that the number of entities increases, rather than decreases, nevertheless the shareholders of the demerged entities are the same people who were shareholders before the demerger and the same business is carried on after the demerger as before, albeit in different entities. Here, we are saying that a merger involves bringing together businesses into a single entity without a purchase, so that the number of entities decreases, and so that the shareholders of the merged entity are the same as the shareholders of the pre-merger entities.

Effect of a merger under CA 2006, s 900 19.6 Once the court’s powers under CA 2006, s 900 are engaged in connection with a scheme of arrangement, the court may (on application by the merging companies) make provision for (amongst other things): ●●

the transfer to the transferee company of the whole or any part of the undertaking and of the property or liabilities of any transferor company;

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the allotting or appropriation by the transferee company of any shares, debentures, policies or other like interests in that company which under the compromise or arrangement are to be allotted or appropriated by that company to or for any person; and/or

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the dissolution, without winding up, of any transferor company section.

An order for the transfer of property or liabilities (commonly known as a ‘vesting order’) will result in: (i) the property being transferred to and vesting in the successor transferee company; and (ii) the liabilities being transferred to and becoming liabilities of the successor transferee company.1 397

19.7 UK company mergers It should be noted that, unlike the standard liquidation procedure followed by a contractual business asset transfer, the transferor companies will not be able to be restored once they have been dissolved pursuant to a court order under CA 2006, s 900. This further attests to the fact that the undertaking, property and liabilities of each transferor company are truly integrated and vested in the successor transferee company, whilst the transferor company or companies truly cease to exist.

1 CA 2006, s 900(3).

Why not used more regularly? 19.7 Since the CA 2006 provides for a domestic merger regime, why is it not used more often? There are three main reasons. The domestic merger regime was available only to public companies 19.8 The domestic merger regime under the CA 2006 was originally thought to have been implemented for public companies only and has very rarely been used in an intra-group context. The reason for this is that for the court to have jurisdiction there must first be a compromise or arrangement proposed between the company and its members and/or creditors.1 In an intragroup context there is often a high level of consensus without the need for the court’s intervention and it therefore was accepted that the court would not have jurisdiction to sanction a scheme in an intra-group context. However, this changed with the advent of SI 2007/2974, which has been widely used in an intra-group context and applies to both public and private companies. The extensive use by UK private companies of SI 2007/2974 led the English courts to be more flexible and to permit UK private companies (and, arguably, private companies who are in the process of being wound up) to use CA 2006, s 900 in an intra-group context rather than other reorganisation methods, provided there is a compelling commercial rationale behind it (see 19.12 below).

1 CA 2006, s 595.

The English court’s powers under CA 2006, s 900 are limited 19.9 Furthermore, the ambit of CA 2006, s 900 has been substantially restricted by the narrow construction applied by the English courts to their power to transfer contracts and other legal relationships which are not capable of transfer or assignment under general provisions of law 398

UK company mergers 19.11 (eg non-assignable contracts).1 This can be contrasted with the powers afforded to the English courts under SI 2007/2974, which recognises the concept of universal succession. In that regard, as seen in the case of Re TSB Nuclear Energy Investment UK Ltd [2014] EWHC 1272 (Ch), the English courts will not make an order for the dissolution of one or more transferor companies under CA 2006, s 900 unless the transferor companies provide evidence that they have taken steps to novate all contracts before the final sanction hearing. As such, an extensive due diligence exercise would need to be carried out before a merger under CA 2006, s 900 is implemented.

1 Nokes v Doncaster Amalgamated Collieries Ltd [1940] AC 1014 at 1053–4.

Not required for owner-managed companies 19.10 For most owner-managed companies, there is no real need to use these complex and potentially expensive CA 2006 provisions. A merger of two companies could be carried out by simply putting one company under the other or by putting both companies under a new holding company, either by share exchange or by a cancellation scheme. The assets can then be transferred taxfree into the holding company, and the subsidiary or subsidiaries can be left dormant or wound up after an appropriate period of time. So far as the authors are aware, whilst there have been a few domestic mergers involving private companies, there has not been an application under CA 2006, Part 27 since the rules came into force on 1 January 1988. If any readers have been involved in such a transaction, we would very much like to hear your views on the experience.

MERGER STRUCTURES 19.11 The simplest form of a merger would be where two companies are simply merged into a single entity (Figure 19.1), containing all the assets of both original companies and with a common pool of shareholders. However, there is no provision in UK company law for a transaction of the type described above, possibly partly because of the logistical problems that such a mechanism throws up. Figure 19.1

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19.11 UK company mergers For example, consider what happens if the original companies have shares denominated in different amounts, or even different currencies: the merged company would perforce have different classes of shares, requiring a preor post-merger reorganisation. Even if the original companies have shares denominated in the same amounts, the companies may have different values. For example, company A is worth £100 and company B is worth £900, and they both have 100 £1 shares in issue. If they are merged, the successor company will be worth £1,000 and will have 200 £1 shares in issue. So the shareholders of each original company will now hold shares worth £500, representing a material gain in value for the shareholders of company A but a loss for the shareholders of company B. So let us look at the likely forms of a merger. For convenience, we will continue to use the terminology of the Consolidating Directive,1 specifically ‘merger by acquisition’ (commonly referred to as a ‘merger by absorption’ under English company law) and ‘merger by formation of a new company’. A merger by acquisition would be an operation whereby one or more companies transfers to another all their assets and liabilities in exchange for the issue to the shareholders of the company or companies being acquired of shares in the acquiring company. A simple merger of this type is illustrated in Figure 19.2. Figure 19.2 Merger by acquisition

In the intra-group context, a merger by acquisition can be carried out as a downstream merger, as shown in Figure 19.3; or an upstream merger (Figure 19.4), as well as a sideways merger, as in Figure 19.8.

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UK company mergers 19.11 Figure 19.3 Downstream merger

A ‘downstream’ merger, where the parent company (as the transferor company) is absorbed by the subsidiary company (as the transferee company), raises a separate issue as to the impact on the capital of the surviving subsidiary company. As previously mentioned, one of the main features of a merger is that the business assets and liabilities of the transferor companies are transferred to the transferee company. Accordingly, where the merger takes effect in the form of an absorption of a parent company into its subsidiary company, the assets which will be transferred will include the shares in the capital of the subsidiary company held by the parent company. From an English company law perspective, UK companies are generally prohibited from acquiring their own shares, subject only to a limited number of exceptions, and a domestic merger under CA 2006, s 900 (or a cross-border merger under SI 2007/2974) does not provide a free-standing exception to the rule (at least without clear guidance to the contrary from the English courts). As such, in order to implement a downstream merger, a court-approved reduction of share capital to cancel the shares held by the parent company in the subsidiary company may be required in order to avoid any problem which might otherwise be caused by the subsidiary company acquiring its own shares when the merger takes effect. However, this is a complex area of law and requires further analysis on a case-by-case basis. An ‘upstream merger’ is where a subsidiary company (as the transferor company) is absorbed by its parent company (as the transferee company) and

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19.11 UK company mergers is not strictly-speaking within the terms of the Consolidating Directive and CA 2006, Part 27. This is because there is no share issue by the transferee company to the shareholders of the transferor company, given that the shareholder and the transferee company are one and the same, and because it is not permitted under English company law for a company to issue shares to itself, as the shareholder of the transferor. However, the concept of an upstream merger does not offend the overall construct of a true merger from an English company law perspective, given that the combined business assets and liabilities will be continued by the transferee company and the ultimate shareholder of the group (shown as ‘Hold Co’ in Figure 19.3) will continue its shareholding in the transferee company as before. Furthermore, the upstream merger is covered under SI 2007/2974 (referred to as a ‘merger by absorption of a wholly owned subsidiary’) and is potentially covered by the Mergers Directive,2 which refers to the situation where ‘a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to the company holding all the securities representing its capital’ (see Chapter 4). Figure 19.4 Upstream merger

A merger by formation of a new company would be an operation whereby two or more companies transfer, to a company that they set up, all their assets and liabilities in exchange for the issue to their shareholders of shares in the new company. Such a transaction is illustrated in Figure 19.5.

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UK company mergers 19.12 Figure 19.5 Merger by formation of a new company

1 Third Council Directive 78/855/EEC of 9 October 1978 concerning mergers of public limited liability companies, and the Sixth Council Directive 82/891/ECC of 17 December 1982 concerning divisions of public limited liability companies. 2 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005).

COMMERCIAL TRANSACTIONS 19.12 Before we go on to look at the legal background and tax analyses of mergers, it is important to ask why companies would undertake mergers as opposed to the conventional acquisition route. There must be a justification for using the merger process rather than another process (eg to obtain a specific tax relief which can only be obtained upon a merger). One scenario might be the formation of joint ventures. For example, consider Figure 19.6, where we see company A transferring all of its undertaking to company B, a member of a different group of companies. Company B issues shares to the shareholders of company A, and company A is dissolved. Company B is now effectively a joint venture company, carrying on the activities previously carried on by companies A and B separately and owned by both the A and B groups.

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19.12 UK company mergers Figure 19.6 Formation of a joint venture

Similarly, the groups could create a joint venture by a merger by formation of a new company. So, in Figure 19.7 we see a new company set up and both companies C and D transfer their undertakings to that new company, which issues shares to the shareholders of companies C and D. The transferor companies, C and D, are then dissolved, leaving the new company carrying on the activities of both as a joint venture of the C and D groups. Figure 19.7 Formation of a joint venture

Possibly the most common use of mergers might be in intra-group reorganisations, where activities are to be amalgamated into a single company or tiers of sub-holding structures are to be collapsed. For example, in Figure 19.8 we see a merger of the activities of sister subsidiaries E and F by acquisition, leaving only subsidiary F. Clearly, a merger by formation of a new company is a less likely scenario in the intra-group context but may still be effected by way of a court-approved scheme of arrangement under CA 2006, s 900. As mentioned above, there have been very few cases where intra-group mergers have been effected in this way. Figure 19.8 Merger of sister companies

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UK company mergers 19.14 In summary, there are a number of possible commercial reasons for companies to merge. As we have already seen, for the reconstruction reliefs to be available, it is necessary to be able to demonstrate the commercial reasons for these transactions to HMRC.

TAX ANALYSIS 19.13 In the main, the tax analyses of a merger of UK companies, whether by acquisition or by formation of a new company, will be the same. The mechanism, liquidation or dissolution without winding up, has no impact on the capital gains position, as we shall see. However, there are two exceptional issues that we will also need to look at: ●●

It is not clear whether the transfer of assets in a dissolution without winding up is an income distribution;

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An upstream merger, where the transferee company cannot lawfully issue shares to the transferor, is not a scheme of reconstruction, and so has a different analysis.

We will cover each of these issues as we go through the analyses.

IS IT A RECONSTRUCTION? 19.14 We will firstly consider whether the transactions qualify as schemes of reconstruction as defined in TCGA 1992, Sch 5AA, and hence whether the appropriate reliefs apply at company and shareholder levels. We will carry out the analysis for a merger by acquisition but the analysis is more or less the same, mutatis mutandis, for a merger by formation of a new company. Let us remind ourselves of the four conditions to be satisfied if the transaction is to be a reconstruction, per TCGA 1992, Sch 5AA: ●●

There must be an issue of ordinary share capital by at least one transferee company to shareholders of the transferor company; and

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That share issue by the transferee company must be pro rata to the shareholdings of the relevant classes of share in the transferor company; and

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For mergers, the business carried on by two or more transferor companies must subsequently be carried on by one (or more) successor companies; or

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There must be a scheme of arrangement under CA 2006, Part 26. 405

19.15 UK company mergers

TCGA 1992, Sch 5AA – the first condition 19.15 Clearly, most mergers involve the issue of shares by the transferee company, so the first condition is satisfied. However, this is not the case in the upstream merger described above (Figure 19.4), where the transferee company cannot issue shares to itself. Therefore, this transaction fails the first condition of TCGA 1992, Sch 5AA and cannot be a reconstruction for tax purposes. As an aside, we shall see in the next chapter that for cross-border mergers this is not a problem, as the transactions are deemed to be schemes of reconstruction. But that deeming does not extend to mergers of UK companies. So, if anything, there is a potential discrimination against the domestic transaction here, in contrast to the EU transaction. The analysis of the upstream merger is covered later in this chapter.

TCGA 1992, Sch 5AA – the second condition 19.16 In a merger by acquisition, the assets and liabilities are transferred to an existing company, which then issues shares to the shareholders of the transferor company. As a result, all the shareholders of the transferor company also receive shares in the transferee company. There is nothing in CA 2006 that says that the shares must be issued pro rata by the transferee company. However, the nature of the rights of shareholders is that all holders of the same class of shares should be treated equally. So it seems likely that the issue of shares to each shareholder would necessarily be pro rata to the shareholdings in the distributing company. Even if company law does not explicitly require a pro rata issue of shares by the transferee company, it follows from the definition in TCGA 1992, Sch 5AA that this is required for tax purposes. Therefore, the second condition is either satisfied, or can be made to be satisfied.

TCGA 1992, Sch 5AA – the third condition 19.17 TCGA 1992, Sch 5AA, para 4 covers amalgamations or mergers. Specifically, TCGA 1992, Sch 5AA, para 4(1)(b)(i) refers to the business of more than one original company being transferred to a single successor company. The successor company may be one of the original companies, as in a merger by acquisition, or it may be a different company, as in a merger by formation of a new company. In either case, however, mergers appear to fit comfortably into the third condition of TCGA 1992, Sch 5AA, too. Therefore, the third condition is satisfied.

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UK company mergers 19.20

TCGA 1992, Sch 5AA – the fourth condition 19.18 We have already seen that the company law covering mergers by dissolution without winding up is governed by CA 2006, Part 26. So, as a matter of trite law, all such mergers must satisfy the fourth condition of TCGA 1992, Sch 5AA. In contrast to most schemes of amalgamation, this means that we can generally rely in these cases on satisfying the fourth condition, not the third!

Conclusion 19.19 Overall, we have just demonstrated that a Third Directive merger is a reconstruction, as defined by TCGA 1992, Sch 5AA. But an upstream merger, which is anyway outside the scope of the Third Directive, is also not a scheme of reconstruction within TCGA 1992, Sch 5AA.

RELIEFS FOR TRANSFEROR COMPANIES 19.20 Where the transferor and transferee companies are not members of the same capital gains group (TCGA 1992, s 170), the company level relief from the charge to corporation tax on chargeable gain is given by TCGA 1992, s 139 (see Chapter 18). The effect of TCGA 1992, s 139 is that the transfer of the undertaking is deemed to be at such a consideration as to give no gain and no loss for capital gains purposes. Where the transferor and transferee companies are in the same group, we would expect TCGA 1992, s 171 to be relevant, instead. Again, the transfer of the undertaking is deemed to be at such a consideration as to give no gain and no loss for capital gains purposes. Both provisions apply equally to both the transferor company, which thereby has no chargeable gain, and to the transferee, which thereby has a base cost equal to the transferor’s base cost (plus indexation, if applicable). We have been through TCGA 1992, s 139 in detail already, but here is a reminder of its requirements: ●●

there must be a scheme of reconstruction (TCGA 1992, s 139(1)(a)). We have already demonstrated that this is the case;

●●

there must be a transfer of all or part of the company’s business to another company (TCGA 1992, s 139(1)(a)), which clearly is a major element of both types of merger;

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19.21 UK company mergers ●●

the companies must be UK tax resident, or within the charge to UK corporation tax on chargeable gains (TCGA 1992, s 139(1)(b), (1A)). We can assume this for the moment, as we are only discussing mergers of UK companies. As we shall see in Chapter 20, there are separate reliefs for cross-border mergers within the EU; and

●●

The transferor company must not receive any consideration for the transfer (TCGA 1992, s 139(1)(c)). Again, we have discussed the legal background that permits a company to give away its assets for no consideration, whether in a liquidation or under the auspices of a CA 2006, Part 26 scheme for which the approval of the courts would be required.

Overall, once again it is clear that most types of merger fulfil the requirements for the corporate relief given by TCGA 1992, s 139 to apply. The transfer of assets to the acquiring or new successor company will be on a no gain/ no loss basis. Accordingly, the transferor company will not be chargeable to corporation tax on a chargeable gain and the assets and liabilities will be treated as having been acquired by the transferee company at the original cost and, for the purposes of indexation, at the date they were originally acquired. For completeness, we would note that the substantial shareholding exemption cannot apply to this form of transaction. Transfers of shareholdings deemed to give rise to no gain and no loss transactions are specifically excluded from the substantial shareholding exemption by TCGA 1992, Sch 7AC, para 6 (see Chapter 11).

IS IT A DISTRIBUTION? 19.21 We also need to consider whether mergers by dissolution without winding up might be distributions – for tax purposes – to the shareholders of the transferor company. So far as the shareholders of the transferor company are concerned, the transfer of assets by the transferor company (in return for the issue of shares to those shareholders) might be a distribution in specie by the transferor company, for tax purposes. It is certainly HMRC’s view that such a transaction is capable of being a distribution, as the transactions of demerger described in CTA 2010, s 1077(1) are mechanically similar to this form of merger. So the exempt distribution legislation would be wholly unnecessary if the transaction were not a distribution, at least in the eyes of the legislators. From a company law perspective, Companies Act 2006, s 829 defines a ‘distribution’ to mean ‘every description of distribution of a company’s assets to its members, whether in cash or otherwise, other than an issue of shares, a bonus issue, a reduction of capital, purchase of cash shares or a distribution on 408

UK company mergers 19.23 the winding up of the company’. So the transaction would appear to meet the CA 2006 definition of a distribution, too. Clearly, in a liquidation merger, CTA 2010, s 1030, which states that any distribution in a winding up is not a distribution for the purposes of the Corporation Tax Acts, applies and the merger will not be a distribution. But by definition this exception from the distributions legislation does not apply to the shareholders of the transferor company in a merger by dissolution without winding up.

Consequences of distribution for corporate shareholders 19.22 This matter is usually irrelevant where the shareholder is a company. Under the global scheme for the taxation of dividends, whether from UK or non-UK resident companies (CTA 2009, Part 9A), all distributions received by a company are prima facie taxable. However, CTA 2009, Part 9A contains a series of exemptions from the taxation of distributions, with the effect that the vast majority of distributions received by a company will not be liable to UK corporation tax. The distribution would also not be a capital distribution, under TCGA 1992, s 122, as this provision cannot apply to distributions that are exempt under CTA 2009, Part 9A (TCGA 1992, s 122(6)). CTA 2009, s 931RA permits dividends and other distributions that are exempt under CTA 2009, Part 9A to be part of a chargeable gains computation (other than under TCGA 1992, s 122). While this suggests that such distributions could be chargeable to corporation tax on chargeable gains under first principles, it equally suggests that the capital gains reconstruction reliefs would be applicable. In other words, if the transfer of assets in a dissolution without winding up is technically a disposal by the shareholders, they should be able to rely on TCGA 1992, s 136, so that the technical disposal by a corporate shareholder is treated as a reorganisation of the share capital, instead. So it appears that the dissolution without winding up route does not create distributions for corporate shareholders of the transferor. But what about individuals or trustee shareholders? There is certainly no relief for such shareholders akin to the CTA 2009, Part 9A exemptions.

Consequences of distribution for non-corporate shareholders 19.23 There is no guidance on this matter in HMRC Manuals or other public statements, to suggest that a dissolution without winding up is not a distribution. The only possible argument is that the word ‘distribution’ is a term which must have the flavour of causing the company’s profits to flow to the shareholders, directly or indirectly. 409

19.24 UK company mergers From an English company law perspective, the rules relating to distributions extend to the transfer by a company of any non-cash assets.1 These requirements form part of the maintenance of capital provisions of the CA 2006, which provide protection to the company’s creditors against abuse of the principle of limited liability and the company transferring any assets beyond the reach of its creditors. Since a merger by way of a court-approved scheme of arrangement under CA 2006, s 900 involves a transfer of assets, it might be thought that these requirements could be considered a distribution and therefore offend the maintenance of capital rules. However, even if that is the case, there is a strong argument that a merger under CA 2006, s 900 does not breach the maintenance of capital rules, given that the transfer of assets is effected pursuant to a statutorily prescribed and court-approved process and (as stated in the Re TSB Nuclear Energy case, at para 16) the court has discretion to withhold approval where it is not satisfied that the creditors will be adequately protected. It is also noteworthy that the 2007 legislation to implement the Company Law Directive on Cross-Border Mergers also gave us what is now CTA 2010, s 1031 which excludes transfers of assets on a cross-border merger from the distributions legislation. As a result, it may be that there is no exemption for non-corporate shareholders from the charge to income tax on distributions. The result would be that the merger of companies owned by non-corporate shareholders would be liable to a charge to income tax, based presumably on the market value of the assets transferred, and such mergers would not be very attractive to the shareholders of the transferor company. There should not be a double charge to tax, ie the shareholder should not also suffer a charge on the deemed part-disposal of the shares of the transferor under TCGA 1992, s 122. This is because TCGA 1992, s 122 can only apply where the distribution is not charged to tax on income (TCGA 1992, s 122(5)(b)). And, in any case, amounts charged to income are generally excluded from capital gains computations (TCGA 1992, ss 37 and 39).

1 CA 2006, s 829(1).

Capital gains consequences of distribution treatment 19.24 One might expect the base cost of the shares issued by the transferee company to have a base cost equal to the market value of the assets transferred and charged as a distribution. But the legislation does not have this effect. There is no disapplication of TCGA 1992, s 136 in these circumstances (19.25), as the actual disposal of the shares in the dissolved company is a different 410

UK company mergers 19.25 transaction from the distribution when its assets are transferred, so the noncorporate shareholder could end up with no extra base cost on the shares in the transferee company, while suffering an income tax charge on the distribution. The only protection from this position might be if TCGA 1992, s 37 can be interpreted to deem the shares to have a base cost equivalent to the amount charged as a distribution, thus avoiding the same amounts being charged to both income tax and capital gains tax. Since we have not seen a merger of UK companies, we are not aware of this point has ever been considered by HMRC or what their view might be.

CAPITAL GAINS RELIEFS FOR NON-CORPORATE SHAREHOLDERS 19.25 In general terms, we would expect that non-corporate shareholders fall into two possible categories. If they are shareholders of the successor company in a merger by acquisition, such as the shareholders of B in Figure 19.2, they have not disposed of or acquired anything and their shares have prima facie not been reduced in value, so they do not require any form of relief. The shareholders of A in Figure 19.2, however, and the shareholders of all the original companies involved in a merger by formation of a new company, will have disposed of their original shares and acquired shares in a different company. As we have already demonstrated, both forms of merger are schemes of reconstruction, so the shareholders would anticipate that the shareholder relief in TCGA 1992, s 136 would apply, to treat the transaction as a reorganisation of share capital and not as a disposal. The three primary conditions for TCGA 1992, s 136 to apply (as always, we are assuming for all purposes that the merger is being carried out for bona fide commercial reasons and not for the avoidance of tax): ●●

there must be an arrangement between a company and its shareholders (TCGA 1992, s 136(1)(a)), which there clearly must be to carry out a merger;

●●

this must be for the purposes of a scheme of reconstruction (TCGA 1992, s 136(1)(a)), which again we have shown to be satisfied; and

●●

another company must issue shares to the shareholders of the first company, pro rata to their shareholdings in that company, whether those original shares are retained or cancelled (TCGA 1992, s 136(1)(b)), which we have already discussed in the context of the second condition of TCGA 1992, Sch 5AA.

So the requirements of TCGA 1992, s 136 appear to be satisfied, and the TCGA 1992, s 136 relief is available. Thus the merger is treated as if there has 411

19.26 UK company mergers been a reorganisation of the share capital of the transferor company and the shareholders end up with shares in the transferee company in place of their original holding in the transferor company. Those shares are treated as if they were acquired at the same time and for the same price as the original shares held in the transferor company.

CAPITAL GAINS RELIEFS FOR CORPORATE SHAREHOLDERS 19.26 So far as UK corporate shareholders are concerned, if the transfer of assets by the transferor company, in return for the issue of shares to those shareholders, is a distribution by the company for tax purposes, we would expect the distributions to be exempt under CTA 2009, Part 9A, so there would be no tax consequences to the shareholders on the receipt of the distribution per se (remember, all the transactions we are describing in this chapter are mergers of UK companies). However, as discussed above (19.22) the merger transaction should still be a reconstruction for chargeable gains purposes, on the basis of CTA 2009, s 931RA. If the transaction is a capital distribution, as it will be in a liquidation merger and should be on a merger by dissolution without winding up, it is a disposal of shares by the shareholder of the transferor company. Prima facie, however, if all the other relevant conditions are satisfied, TCGA 1992, s 136 should apply to the corporate shareholder as it does to the non-corporate shareholder. However, what if the deemed part disposal is subject to the substantial shareholding exemption? This might apply, for example, if the company being liquidated or dissolved is a trading company. The interaction of the two codes is covered in Chapter 11. In brief, however, the analysis is as follows: ●●

TCGA 1992, Sch 7AC, para 4 tells us to ignore the ‘no disposal’ fiction of TCGA 1992, s 136;

●●

TCGA 1992, s 171 would not be in point here, even if the merger is within a group. This is because TCGA 1992, s 171 requires a disposal of assets (in this case, the part disposal of the shares of the transferor company) to a company in the same group. But, by virtue of the fact that the transferor company is dissolved, its shares are not disposed of to anyone, so TCGA 1992, s 171 cannot apply;

●●

the deemed part-disposal would therefore appear to qualify for the substantial shareholding exemption; and

●●

TCGA 1992, Sch 7AC, para 4(3) tells us that the reconstruction reliefs, ie TCGA 1992, s 127 via TCGA 1992, s 136, do not apply where the substantial shareholding exemption is available. 412

UK company mergers 19.29 So the substantial shareholding exemption would supersede the reconstruction reliefs if it is available and the disposal on liquidation or dissolution of the company would merely be a tax exempt disposal. None of this, of course, prevents the transfer of assets by that company in liquidation or dissolution from qualifying for the no gain, no loss treatment of TCGA 1992, s 139.

UPSTREAM MERGERS: A SPECIAL CASE 19.27 Finally, as mentioned above, the upstream merger (see Figure 19.4 above) cannot be a reconstruction, so that none of the reconstruction reliefs are available. In most cases, however, we would anticipate the transaction being in a group context, so that the parent owns at least 75 per cent, and more usually 100 per cent, of the shares of the transferor subsidiary. So the transfer of assets will fall within TCGA 1992, s 171(1)and will be deemed to occur at a no gain, no loss consideration. The position is more complex in terms of the disposal by the parent of its shares in the subsidiary that is being dissolved. Unless the companies satisfy the conditions for the substantial shareholding exemption to apply, there is no obvious shelter for any gain that might arise to the parent company on an upstream merger.

FURTHER ISSUES RELATING TO MERGERS TCGA 1992, s 179 exposure 19.28 On a simple merger of companies, no charge under TCGA 1992, s 179 is likely to arise. However, particularly where companies in the same group are merged, a charge might arise under TCGA 1992, s 179 if the transferee company is later sold out of the group. Nor can this be prevented by retention of the transferor company, which is of course dissolved as part of the merger process.

Other tax issues 19.29 Other tax issues, such as capital allowances balancing charges and crystallising held-over gains may theoretically also arise with mergers. Within a group, of course, the provisions of CTA 2010, Part 22, Chapter 1 (transfers of trade without a change of ownership) should preserve losses and the capital 413

19.30 UK company mergers allowances position, as the companies will be under 75 per cent common ownership.

CONCLUSION 19.30 Generally speaking, people do not think of some of these transactions as being mergers. And there is a widespread lack of awareness of the possibility of a transaction involving dissolution without liquidation. But this chapter is the platform on which the cross-border mergers rules have been built. These are covered in Chapter 20 and it is at least possible that the increased focus on crossborder transactions might highlight the attractions of domestic mergers, too.

STAMP TAXES 19.31 The transactions reviewed in this chapter involve transfers of assets of one company to another. SDLT (or, in Scotland, LBTT) may arise if any interests in UK land are involved, and stamp duty may arise if the assets transferred include shares or securities within the stamp duty net. In the case of upstream, downstream and sister company mergers (Figures 19.3, 19.4 and 19.8), provided all transfers occur within a 75 per cent worldwide corporate group, it should be possible to claim group relief in respect of both SDLT and stamp duty as explained in Chapter 2. Where the transaction proceeds under supervision of the court, it may be that the transfer of the assets happens directly under a court order. This is still a transfer for consideration for SDLT purposes, potentially requiring a claim to group relief. However, where shares and securities are involved, it will not normally give rise to a transfer for stamp duty purposes. In all of the other cases, unless the merging companies happen to be owned by identical groups of shareholders, the merger will involve a degree of change in the economic ownership of the assets transferred. This means it will not generally be possible to claim stamp tax reconstruction reliefs as it is of the essence of these reliefs that there must be no change in economic ownership. It may be possible to claim acquisition relief to reduce the rate of SDLT to 0.5%, or, where appropriate, to reduce the amount of LBTT to a proportion of what it would otherwise be. See Chapter 2 for a discussion of these reliefs.

VALUE ADDED TAX 19.32 The VAT implications of the various ways in which mergers can be carried out are considered in the appropriate chapters. 414

Chapter 20

Cross-border mergers

INTRODUCTION 20.1 The legal background for cross-border mergers arises from EU legislation, as explained in more detail in Chapter 4. This chapter must, of course, be read subject to any on-going developments in the tax legislation in the UK as a result of the UK leaving the EU on 31 January 2020. The future status of all EU Regulations, Directives and case law in relation to UK law will entirely depend on the terms under which the UK ultimately leaves the EU and how domestic statute evolves over time. Domestic legislation enacted under the influence of EU law will remain in force immediately after Brexit but will now be subject to possible amendment by the UK Parliament after the IP completion day, currently anticipated to be 11pm on 31 December 2020. To contextualise the existence of tax merger provisions within UK statute, the concept was introduced by the 1990 Mergers Directive1 and, although the Directive referred to ‘cross-border mergers’, there was no requirement for Member States to permit cross-border mergers as a matter of domestic law. The enactment of the European Company Statute2 in 2001 required that Member States recognise European Companies (known as ‘Societas Europaea’ or ‘SEs’) and also permitted their formation by merger, from 2004. The original UK tax legislation to permit the formation of SEs by merger, as TCGA 1992, ss 140E–140G, was described in the first edition of this book. In 2005, the Company Law Directive on Cross-Border Mergers3, was enacted. This requires Member States that permit company mergers domestically to permit such transactions between companies in different Member States, too. Member States had to have the legislation in place from 15 December 2007. The UK enabling provisions are in FA 2007, s 110 and the legislation was introduced by regulations amending TCGA 1992, ss 140E–140G. Other than relatively minor amendments to cross-references to other legislation, there have been no material changes to these provisions since 2007. The Taxes (Amendments) (EU Exit) Regulations 2019 (SI 2019/689) have made 415

20.2 Cross-border mergers some prospective amendments to TCGA 1992, ss 140A–140L to allow these provisions to apply in circumstances when the UK is no longer an EU Member State from the relevant ‘exit day’. This has been included in the commentary below, where relevant. The UK company law regime for cross-border mergers is set out in Chapter 4.

1 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005). 2 Council Regulation (EC) No 2157/2001 of 8 October 2001 on the Statute for a European company (SE). 3 Directive 2005/56/EC of the European Parliament and of the Council of 26 October 2005 on cross-border mergers of limited liability companies.

DEFINITIONS OF A MERGER 20.2 Before we get into the legislation, let us remind ourselves about the types of transaction we are considering. The only mergers we need to consider in the cross-border context are those defined by the Mergers Directive. Article 2 defines a merger as: ‘… an operation whereby: ●●

one or more companies, on being dissolved without going into liquidation, transfer all their assets and liabilities to another existing company in exchange for the issue to their shareholders of securities representing the capital of that other company, and, if applicable, a cash payment not exceeding 10% of the nominal value, or, in the absence of a nominal value, of the accounting par value of those securities,

●●

two or more companies, on being dissolved without going into liquidation, transfer all their assets and liabilities to a company that they form, in exchange for the issue to their shareholders of securities representing the capital of that new company, and, if applicable, a cash payment not exceeding 10% of the nominal value, or in the absence of a nominal value, of the accounting par value of those securities,

●●

a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to the company holding all the securities representing its capital.’

The first two of these are mergers by acquisition and mergers by formation of a new company, which we first saw described in the Third Directive1 416

Cross-border mergers 20.3 in Chapter 4, and which are demonstrated in Figures 19.2, 19.3 and 20.5. The final transaction is the upstream merger shown in Figure 19.4, to which we have already noted that the Third Directive does not apply. The only difference is that in Chapter 19 we assumed that the merging companies are all UK resident, whereas for the purposes of this chapter we must assume that one is UK resident and the other is resident in another Member State. It is also worth noting that the wording requires an issue of securities (not just shares) to the holders of capital of the transferor company. This is translated into UK legislation as requiring an issue of shares or debentures by the transferee company to the holders of shares or debentures of the transferor company.

1 Third Council Directive 78/855/EEC of 9 October 1978 concerning mergers of public limited liability companies, and the Sixth Council Directive 82/891/EEC of 17 December 1982 concerning divisions of public limited liability companies.

LEGAL BACKGROUND 20.3 The new UK rules were introduced by secondary legislation, as already discussed, via the enabling legislation at FA 2007, s 1101. The revised rules were then introduced by SI 2007/3186, which extended TCGA 1992, ss 140E–140G to apply to all company mergers: mergers to form SEs, mergers of ordinary companies and mergers to form SCEs. These new rules were then amended (or corrected, perhaps) by SI 2008/15792. Why were these changes introduced via secondary legislation? The stated reason, in the Consultation Document of November 20063, is: ‘Due to the extremely small number of companies that have made use of the current range of EMTD4 transactions and the considerable extent of legislative change involved, the Government considers that inclusion within the Finance Bill of these amendments extending the range of possible EMTD transactions, cannot be justified. The Government therefore intends that the amendments will be made via secondary legislation through the insertion of a power enabling it to do so in Finance Bill 2007.’ This approach also meant that it was not necessary to bring the legislation into FA 2007 and that, instead, there was ample time to consult widely about the changes. The regulations were eventually laid in November 2007, allowing six months more preparation time than would have been the case if they had been included in the Finance Bill. While this may have meant a period of

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20.4 Cross-border mergers some uncertainty for business, it is probably fair to say that none of our clients considered themselves to have been adversely affected by this. The use of regulations also means that it is easier to correct the provisions if there are any errors in implementation of the Directive. Let us now look at the enabling legislation.

1 Revised company law regulations were also required to permit cross-border mergers, but these are outside the scope of this book. 2 Particularly galling as we had just finished writing this chapter when the new regulation appeared, so a certain amount of rewriting was required! 3 ‘Amendment to the European Mergers Tax Directive: Technical note and draft clauses to implement the necessary UK law changes’ (HMRC) 10 November 2006. 4 That is, Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005) (see Chapters 4 and 26).

FA 2007, S 110 MERGERS DIRECTIVE REGULATIONS FA 2007, s 110(1) – scope of transactions to which regulations can apply 20.4 ‘(1) The Treasury may by regulations make provision about – (a) the tax consequences of a merger to form an SE or SCE, (b) the tax consequences of a merger where – (i)

each party to the merger is resident in a member State, and

(ii) the parties are not all resident in the same member State, (c)

the tax consequences of a transfer between companies of a business or part of a business, where – (i)

each party to the transfer is resident in a member State, and

(ii) the parties are not all resident in the same member State, (d) the tax consequences of a share exchange to which section 135 of TCGA 1992 (exchange of securities) applies where companies A and B are resident in different member States, (e)

the residence of an SE or SCE.’

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Cross-border mergers 20.7 Analysis 20.5 This sets out the scope of the enabling legislation, in terms of the transactions about which the regulations may validly be made. FA 2007, s 110(1)(a) and (b) are relevant to mergers and will be discussed in this chapter. Note that the new rules only apply to cross-border mergers and not to domestic mergers, which were described in Chapter 19. Our view is that it would have been preferable to have a single regime for all permissible mergers, rather than having different regimes for domestic and cross-border mergers. An interesting point to note is that the regulations can only apply to effect legislation in respect of mergers where each party is resident in an EU Member State. Whilst SI 2019/689 has amended TCGA 1992, ss 140A–140L, there appears to be a slight disconnect between how these provisions all interact and operate. FA 2007, s 110(2) – scope of existing legislation to which regulations can apply 20.6 ‘(2) Regulations may, in particular, make provision – (a) about the taxation of chargeable gains (including conferring relief from taxation in relation to transfers or mergers which satisfy specified conditions), (b) conferring relief from taxation on a distribution of a company which satisfies specified conditions, (c)

about the treatment of securities issued on a transfer or merger,

(d) about the treatment of loan relationships, (e)

about the treatment of derivative contracts,

(f)

about the treatment of intangible fixed assets, and

(g) about capital allowances.’ Analysis 20.7 This sets out the scope of the areas of UK tax law that may be amended by the regulations. While this book is generally concerned with capital gains legislation, we will look at some of the other areas briefly, too.

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20.8 Cross-border mergers FA 2007, s 110(3) – restriction of scope of regulations 20.8 ‘(3) Regulations may make provision only if the Treasury think it necessary or expedient for the purposes of complying with the United Kingdom‘s obligations under the Mergers Directive.’ Analysis 20.9 This provides that the Treasury cannot amend this legislation for any other purpose than compliance with the Mergers Directive. This is a useful safeguard to prevent excessive legislation by regulation (and, as we saw in 9.21, meant that amendments outside the scope of this provision were ultra vires). Again, this is relevant in the context of Brexit as the UK will no longer have obligations under the EU Merger Directive after Brexit, so any enabling or amending of the provisions (potentially including the provisions in SI 2019/689) could similarly be argued to be considered ultra vires, especially in a ‘hard Brexit’ where no transitional period or rules would exist. That said, we would expect Parliament to amend this enabling legislation, if necessary, to remove or amend this restriction. FA 2007, s 110(4) to (6) – definitions and restrictions 20.10 ‘(4) In this section – “the Mergers Directive” means Council Directive 2009/133/EC, “SCE” means an SCE formed in accordance with Council Regulation (EC) 1435/2003 on the Statute for a European Cooperative Society, and “SE” means an SE formed in accordance with Council Regulation (EC) 2157/2001 on the Statute for a European Company. (5) Regulations under this section may – (a) amend the Taxes Acts, (b) make incidental or consequential amendments of enactments other than the Taxes Acts, (c)

make provision having retrospective effect,

(d)

make provision generally or only for specified cases or circumstances,

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Cross-border mergers 20.13 (e)

make different provision for different cases or circumstances,

(f)

make incidental, consequential or transitional provision.

(6) In this section “the Taxes Acts” has the meaning given by section 118(1) of TMA 1970.’ Analysis 20.11 These provisions are self-explanatory. It is interesting, however, to note that there is scope for retrospective amendments in FA 2007, s 110(5)(c). We assume that this is to ensure that any inadvertent failures to properly and fully implement the Directive can be corrected efficiently and without undue concern about when the correct provisions are applicable. And, as it happens, the regulations were made effective from dates prior to the enactment of FA 2007.

THE UK REGULATIONS 20.12 The Corporation Tax (Implementation of the Mergers Directive) Regulations 2007 (SI 2007/3186) came into force on 29 November 2007 and the correcting regulations, the Corporation Tax (Implementation of the Mergers Directive) Regulations 2008 (SI 2008/1579) came into force on 8 July 2008. However, both sets of regulations were effective for most purposes from 1 January 2007, and from 18 August 2006 for provisions relating to SCEs. For the purposes of cross-border mergers, the regulations revise TCGA 1992, ss 140E–140G, which were introduced in 2005 to permit the formation of SEs by merger, and add a new TCGA 1992, s 140GA.

THE LEGISLATION 20.13 The legislation at TCGA 1992, ss 140E–140GA has a number of components. TCGA 1992, s 140E provides relief for mergers whereby chargeable assets remain subject to UK taxation, being transferred to a company that is either UK resident or carrying on a trade through a permanent establishment in the UK. There are similar reliefs in respect of capital allowances, intangible fixed assets, loan relationships and derivatives. TCGA 1992, s 140F provides relief for mergers where a non-UK permanent establishment of a UK company is transferred to a company resident in 421

20.14 Cross-border mergers another Member State. Again, there are similar reliefs for intangible fixed assets, loan relationships and derivatives. For both types of merger, there is also a shareholder relief at TCGA 1992, s 140Gand a relief from other capital gains charges at TCGA 1992, s 140GA. There are also a number of other consequential amendments, particularly covering legislation relating to chargeable gains in groups, which is outside the scope of this book. We will describe the legislation for chargeable assets in detail, then highlight the relevant provisions for capital allowances assets, intangible fixed assets, loan relationships and derivative contracts.

TCGA 1992, S 140E: MERGERS LEAVING ASSETS WITHIN UK TAX CHARGE 20.14 This legislation provides relief for mergers whereby assets remain subject to UK tax. The main relief is for chargeable assets, at TCGA 1992, s 140E. TCGA 1992, s 140E(1) – scope of legislation 20.15 ‘(1) This section applies on a merger which satisfies the conditions specified in subsection (2), where – (a) an SE is formed by the merger of two or more companies in accordance with Articles 2(1) and 17(2)(a) or (b) of Council Regulation (EC) 2157/2001 on the Statute for a European Company (Societas Europaea), (b) an SCE is formed by the merger of two or more cooperative societies, at least one of which is a registered society within the meaning of the Co-operative and Community Benefit Societies Act 2014 or a society registered or treated as registered under the Industrial and Provident Societies Act (Northern Ireland) 1969, in accordance with Articles 2(1) and 19 of Council Regulation (EC) 1435/2003 on the Statute for a European Cooperative Society (SCE), (c)

the merger is effected by the transfer by one or more companies of all their assets and liabilities to a single existing company, or

(d) the merger is effected by the transfer by two or more companies of all their assets and liabilities to a single new company

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Cross-border mergers 20.20 (other than an SE or an SCE) in exchange for the issue by the transferee, to each person holding shares in or debentures of a transferor, of shares or debentures.’ Analysis 20.16 This gives the pre-conditions for the provision to apply. TCGA 1992, s 140E applies to various types of merger. A merger to form an SE 20.17 This is identical to the original 2005 legislation and requires that an SE be formed by the merger of two or more companies in accordance with the European Company Statute. A merger to form an SCE 20.18 This is a new provision, introduced to comply with the European Company Statute as it applies to the newly created concept of a European Cooperative Society. The only UK entities that satisfy the criteria are Industrial and Provident Societies, so this provision permits mergers of UK Industrial and Provident Societies with entities from other Member States to form an SCE. It is worth noting that, as a result of the enactment of the Co-operative and Community Benefit Societies Act 2014, TCGA 1992, ss 140E and 140F have been amended to remove references to the Industrial and Providential Societies Act 1965. A merger by acquisition 20.19 This transaction does specifically require the issue of securities by the transferee company to the shareholders or debenture holders of the transferor company, as that requirement is introduced by TCGA 1992, s 140E(2)(d). So this provision encompasses all mergers by acquisition described in Chapters 4 and 19, including the upstream merger (see Figures 19.2 to 19.5). A merger by formation of a new company 20.20 This transaction accords more completely with the transaction described in the amended Mergers Directive and does require the issue of securities by the transferee company to the shareholders or debenture holders of the transferor. However, it is not clear that it necessarily includes the payment of any cash consideration, as permitted by the Mergers Directive.

423

20.21 Cross-border mergers TCGA 1992, s 140E(2) – conditions for legislation to apply 20.21 ‘(2) The conditions mentioned in subsection (1) are that – (a) each of the merging companies is resident in a Member State, (b) the merging companies are not all resident in the same State, (c)

section 139 does not apply to any qualifying transferred assets,

(d) in the case of a merger to which subsection (1)(a), (b) or (c) applies, either – (i)

the transfer of assets and liabilities is made in exchange for the issue by the transferee, to each person holding shares in or debentures of a transferor, of shares or debentures, or

(ii) sub-paragraph (i) is not satisfied by reason only, and to the extent only, that the transferee is prevented from complying with sub-paragraph (i) by section 658 of the Companies Act 2006 (rule against limited company acquiring own shares) or a corresponding provision of the law of another member State preventing the issue of shares or debentures to itself, and (e)

in the case of a merger to which subsection (1)(c) or (d) applies, in the course of the merger each transferor ceases to exist without being in liquidation (within the meaning given by section 247 of the Insolvency Act 1986).’

Analysis 20.22 There are a series of conditions to be satisfied if a merger is to qualify for the relief at TCGA 1992, s 140E. First, each merging company must be resident in a Member State, but not in the same Member State. So, relief is not available for mergers with companies from outside the EU or for mergers of UK companies. To allow TCGA 1992, s 140E to operate in a post-Brexit environment, the words ‘Member State’ and ‘State’ in TCGA 1992, s 140E(2)(a) and (b) respectively have been replaced with ‘relevant state’. This is defined as the UK or an EU Member State and has been introduced by SI 2019/689 from the ‘exit day’ (being the day of Brexit) to allow this provision to continue to apply as before. The effect of this amendment is not intended to allow TCGA 1992, s 140E to apply to mergers with companies outside the EU.

424

Cross-border mergers 20.22 Secondly, TCGA 1992, s 139 should not apply to any qualifying transferred assets (as defined in TCGA 1992, s 140E(4)). This is to prevent double relief, as clearly there is no need for relief under TCGA 1992, s 140E if relief is already available under TCGA 1992, s 139. Conversely, of course, if relief is not available under TCGA 1992, s 139 for an EU merger transaction, the relief under TCGA 1992, s 140E is necessary to ensure that the UK is compliant with the Mergers Directive. One scenario when TCGA 1992, s 139 would not apply would be the upstream merger. As we have seen, such a merger cannot be a scheme of reconstruction within TCGA 1992, Schedule 5AA, as there is no issue of shares. So TCGA 1992, s 140E would be the only relieving provision for upstream cross-border mergers. But, as noted above, it would not apply to upstream mergers of UK companies, which would have to rely on TCGA 1992, s 171. For mergers to form SEs or SCEs, and for mergers by acquisition, the requirement for an issue of securities by the transferee company to the shareholders or debenture holders of the transferor is introduced here. However, there is a specific exception for this requirement where the issue of shares would be prohibited by company law rules (in the UK or elsewhere) preventing a company issuing shares to itself. So, this explicitly allows an upstream merger by acquisition. For general mergers of companies, whether by acquisition or by formation of a new company, this provision also introduces the requirement that the transferor company or companies cease to exist, without liquidation. This is interesting as the legislation doesn’t use either of the phrases we are used to, dissolution without winding up or winding up without liquidation. Given that this legislation is intended to enact the Directives into UK law, however, we assume that this terminology is intended to encompass all Mergers Directive mergers by dissolution without liquidation. This does appear to mean, however, that it may not be permissible to carry out cross-border mergers by liquidation, if the transferor company is looking to take advantage of the relief under TCGA 1992, s 140E. So, UK crossborder mergers may be forced to use the court-ordered winding up without liquidation. One concern we have about this provision is that it doesn’t appear to take into account the possibility that some part of the consideration for a merger might be paid in cash. Both the Third Company Law Directive and the Mergers Directive refer to the possibility of paying out cash up to 10 per cent of the nominal value of the shares issued in a merger. But TCGA 1992, s 140E(2)(d)

425

20.23 Cross-border mergers could be read as suggesting that if any cash consideration is paid then the condition is failed and the merger will not qualify for relief under TCGA 1992, s 140E at all. In the experience of the authors, a purposive reading of the legislation should be used to import an implicit 10 per cent cash consideration allowance. Transactions have proceeded on this basis, although in their knowledge not without a conservative estimation of the possible tax charge that may arise if the legislation were not to be read in this way. It certainly would not be wise to structure a transaction with a cash consideration of greater than 10 per cent, unless such a tax charge (on the entire amount of the ‘merger gain’) were computed and deemed to be acceptable in advance. When there is a possibility that the Mergers Directive may not apply on a multi-jurisdictional merger due to the inclusion of a cash element, in the experience of the authors a dual approach may be prudent, whereby under each of the relevant jurisdictions the relevant local law is reviewed for possible tax relieving provisions, and the gain computed on the basis that only those relieving provisions apply. TCGA 1992, s 140E(3) – effect of the legislation 20.23 ‘(3) Where this section applies, qualifying transferred assets shall be treated for the purposes of corporation tax on chargeable gains as if acquired by the transferee for a consideration resulting in neither gain nor loss for the transferor.’ Analysis 20.24 This is self-explanatory and has the same effect as TCGA 1992, s 139. Where the legislation applies, a transfer of qualifying transferred assets will be treated as if the SE has acquired them for a consideration resulting in neither a gain nor a loss for the transferor. This relief, like most of the reconstruction reliefs, is mandatory and must therefore apply if the appropriate conditions are satisfied. There is no provision for the companies or the shareholders to opt out of it. And HMRC must apply the relief unless the merger is not carried out for bona fide commercial reasons or is part of tax-avoidance arrangements (see TCGA 1992, s 140E(8)). It is interesting to contrast this to the Mergers Directive legislation implemented in 1992. The reliefs under TCGA 1992, ss 140A and 140C and their equivalents are both voluntary and any combination of the available reliefs can be claimed. 426

Cross-border mergers 20.26 TCGA 1992, s 140E(4) to (6) – definition of a qualifying transferred asset 20.25 ‘(4) For the purposes of subsections (2) and (3) an asset is a qualifying transferred asset if – (a) it is transferred to the transferee as part of the process of the merger, and (b) subsections (5) and (6) are satisfied in respect of it. (5) This subsection is satisfied in respect of a transferred asset if – (a) the transferor is resident in the United Kingdom at the time of the transfer, or (b) any gain that would have accrued to the transferor, had it disposed of the asset immediately before the time of the transfer, would have been a chargeable gain forming part of the transferor’s chargeable profits in accordance with section 2B(3). (6) This subsection is satisfied in respect of a transferred asset if – (a) the transferee is resident in the United Kingdom at the time of the transfer, or (b) any gain that would accrue to the transferee were it to dispose of the asset immediately after the transfer would be a chargeable gain forming part of the transferee’s chargeable profits in accordance with section 2B(3).’ Analysis 20.26 Essentially, these provisions ensure that TCGA 1992, s 140E only applies where the assets concerned, which were originally within the UK tax net, remain in the UK, either as assets of a UK company or of the UK permanent establishment of a non-UK company. These provisions define a ‘qualifying transferred asset’ as one which is an asset transferred to a company as part of the process of merger by which that company is formed, so long as two conditions are satisfied in respect of that asset. The first condition – TCGA 1992, s 140E(5) – is that either the transferor company is resident in the UK at the time of the transfer or it is a non-UK company carrying on a trade through a permanent establishment (PE) in the UK, such that any gain on the disposal would have formed part of the transferor’s chargeable profits. (For the avoidance of doubt, if the PE is not trading, then TCGA 1992, s 2B(3) does not apply and any gain on disposal of the assets of the PE would not be chargeable to UK corporation tax. Therefore, no relief is required for the merger of non-trading branches or permanent establishments). 427

20.27 Cross-border mergers The second condition – TCGA 1992, s 140E(6) – requires the transferee company, which is the merged entity, to be a company resident in the UK at the time of the transfer of assets or, alternatively, for the transferee to be a company carrying on a trade in the UK through a permanent establishment, such that any gain on subsequent disposal of the asset would be a chargeable gain forming part of the company’s chargeable profits in the UK. An important point to note is that TCGA 1992, s 140E is therefore very similar to TCGA 1992, s 171 (in that it provides for the deemed consideration to be for an amount that secures that neither a gain nor a loss arises in the transferor), but it does not require that the transferor and transferee are members of the same group. TCGA 1992, s 140E is therefore very helpful in a third-party context. TCGA 1992, s 140E(7) – consequential changes 20.27 ‘(7) If subsection (2)(d)(ii) applies in relation to a transfer of assets and liabilities on a merger (in whole or in part), sections 24 and 122 do not apply.’ Analysis 20.28 These provisions ensure that other provisions of the chargeable gains legislation are not inadvertently invoked by a merger where there is no consideration by way of an issue of securities to the shareholders or debenture holders of a transferor company. This therefore only appears to be relevant to upstream mergers within TCGA 1992, s 140E(2)(d)(ii). TCGA 1992, s 24 provides for a notional disposal where an asset is lost, destroyed or becomes of negligible value, as might be the case where a company ‘ceases to exist without being in liquidation’, as required by TCGA 1992, s 140E(2)(e). We assume that the intention here is to prevent a gain arising under TCGA 1992, s 24, when the shares in the subsidiary cease to exist, since the upstream merger is intended to be on a no gain, no loss basis. This provision would also prevent a transferee parent company in an upstream merger being able to claim an allowable capital loss in relation to the ‘loss’ of its subsidiary when it ceases to exist. The reference to TCGA 1992, s 122 may now be otiose. If a company ‘ceases to exist without being in liquidation’, the upstream transfer of assets might be a distribution. If it is, it is highly likely to be in an exempt class of CTA 2009, Part 9A and hence also not a capital distribution, by virtue of TCGA 1992, s 122(6) (brought in by FA 2011). And if the upstream transfer of assets is not a distribution, then TCGA 1992, s 122 cannot apply, anyway, as it only applies to distributions as defined in CTA 2010, Part 23, Chapter 2.

428

Cross-border mergers 20.31 Note that this provision appears to have the same effect as TCGA 1992, s 140GA, inserted by SI 2008/1579. TCGA 1992, s 140E(8) – commercial and tax avoidance tests 20.29 ‘(8) This section does not apply in relation to a merger if – (a) it is not effected for bona fide commercial reasons, or (b) it forms part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoiding liability to corporation tax, capital gains tax or income tax, and section 138 (clearance in advance) shall apply to this subsection as it applies to section 137 (with any necessary modifications).’ Analysis 20.30 The provision is disapplied if the merger is not carried out for bona fide commercial reasons or forms part of a scheme or arrangements with a whole or main purpose of avoiding liability to corporation tax, capital gains tax or income tax. The provisions in TCGA 1992, s 138 for clearance in advance apply to this provision as they do to TCGA 1992, s 137, subject to any necessary modifications. The fact that there is a clearance procedure does not suggest that there is any choice over the application of the relief. This merely gives certainty of treatment to taxpayers in advance of carrying out the transaction that HMRC will not apply these anti-avoidance measures and deny the relief. (This is, of course, the same as the position for relief under TCGA 1992, s 135, 136 or 139.) TCGA 1992, s 140E(9) – definitions 20.31 ‘(9) In this section – (a) “cooperative society” means a society registered under the Co-operative and Community Benefit Societies Act 2014, a society registered or treated as registered under the Industrial and Provident Societies Act (Northern Ireland) 1969 or a similar society established in accordance with the law of a Member State other than the United Kingdom, (b) “transferor” means –

429

20.32 Cross-border mergers (i)

in relation to a merger to which subsection (1)(a) applies, each company merging to form the SE,

(ii) in relation to a merger to which subsection (1)(b) applies, each cooperative society merging to form the SCE, and (iii) in relation to a merger to which subsection (1)(c) or (d) applies, each company transferring all of its assets and liabilities, (c)

‘transferee’ means – (i)

in relation to a merger to which subsection (1)(a) applies, the SE,

(ii) in relation to a merger to which subsection (1)(b) applies, the SCE, and (iii) in relation to a merger to which subsection (1)(c) or (d) applies, the company to which assets and liabilities are transferred, and (d) references in subsections (1)(c) and (2) to (7) to a company include references to a cooperative society.’ Analysis 20.32

These definitions are self-explanatory.

It is, however, noteworthy that the definition of residence of a transferee SE, in TCGA 1992, s 140E(6) in the old legislation, has not been replicated for transferee companies in the new TCGA 1992, s 140E, although it does appear in the legislation relating to other regimes. It is not clear whether this is an oversight or a deliberate omission.

FURTHER RELIEFS FOR MERGERS THAT LEAVE ASSETS WITHIN THE UK TAX CHARGE 20.33 The regulations introduce a series of further reliefs for such mergers, for assets that are dealt with under different tax regimes. These are the rules for intangible fixed assets (CTA 2009, Part 8), loan relationships (CTA 2009, Part 5) and derivatives (CTA 2009, Part 7). All of these reliefs operate in very similar ways to the capital gains reliefs. Rather than analysing each regime in detail, which would necessarily involve a great deal of duplication, we will highlight only the main points of interest for each. In the interests of space, we have chosen not to reproduce all the legislation. 430

Cross-border mergers 20.35 The Taxes (Amendments) (EU Exit) Regulations 2019 (SI 2019/689) similarly amend each of these regimes to allow the relevant provisions to operate in a post-Brexit environment.

INTANGIBLE FIXED ASSETS – EUROPEAN CROSS-BORDER MERGER: TRANSFER OF UK BUSINESS 20.34

The legislation is now at CTA 2009, ss 821–823.

These provisions operate on the same transactions as TCGA 1992, s 140E(1) and have a similar effect. That is, where the conditions of CTA 2009, s 821 are satisfied, a transfer of qualifying transferred assets is treated as tax neutral (as defined in CTA 2009, s 776). This means that the transferor is not treated as having realised the intangible fixed asset and the transferee is treated as standing in the shoes of the transferor as ‘having held the asset at all times when it was held by the transferor and as having done all such things in relation to the asset as were done by the transferor’. This relief only applies if the normal tax neutral for schemes of reconstruction, at CTA 2009, s 818, which is the equivalent of TCGA 1992, s 139, does not apply. The definition of a ‘qualifying transferred asset’ is an asset transferred as part of the process of merger and which is a chargeable intangible asset in relation to the transferor immediately before the transfer and also a chargeable intangible asset in relation to the transferee immediately after the transfer. This is effectively the same as the requirements of TCGA 1992, s 140E. That is, TCGA 1992, s 140E requires chargeable assets to be within the charge to UK corporation tax and, for CTA 2009, s 822(2)(b) an intangible fixed asset is only a chargeable intangible asset if any gains on realisation of the asset by the company are chargeable to UK corporation tax. Again, this new provision only applies if the merger is effected for bona fide commercial reasons and does not form part of a tax avoidance scheme (CTA 2009, s 832). Clearance in advance is made available under CTA 2009, ss 831 and 832, which are almost identical to the capital gains provisions.

LOAN RELATIONSHIPS: EUROPEAN CROSS-BORDER MERGER 20.35

The legislation is now at CTA 2009, s 431 et seq.

These provisions operate on the same transactions as TCGA 1992, s 140E(1) and have a similar effect. That is, where the conditions of CTA 2009, s 431 431

20.36 Cross-border mergers are satisfied, a transfer of a loan relationship is treated as taking place at the notional carrying value (CTA 2009, s 433). This should mean an effectively tax neutral transfer. There is no mention of a TCGA 1992, s 139 equivalent in the loan relationships regime, as there isn’t one. However, no relief is available where loan relationships are dealt with under fair value accounting principles by the transferor company (CTA 2009, s 434). In this case, the transferor must bring into account the fair value of the asset (or liability), so the transfer may not be tax neutral. In practice, this would usually mean that the loan relationship is taxed on a ‘mark-to-market’ basis and, as such, the merger itself has not technically given rise to the tax charge. Again, the relief only applies if the merger is effected for bona fide commercial reasons and does not form part of a tax avoidance scheme, and a system for clearance in advance is available. There is also a regime TAAR which applies to the loan relationship regime (see CTA 2009, s 455B et seq) which should be considered.

DERIVATIVE CONTRACTS: EUROPEAN CROSS-BORDER MERGER 20.36

The legislation is now at CTA 2009, s 682 et seq.

These provisions operate on the same transactions as TCGA 1992, s 140E(1) and are essentially the same as those for loan relationships. That is, where the conditions of CTA 2009, s 682 are satisfied, a transfer of the rights and liabilities under a derivative contract are treated as taking place at the notional carrying value. This should mean an effectively tax neutral transfer. There is no mention of a TCGA 1992, s 139 equivalent in the derivative contracts regime, as, again, there isn’t one. However, no relief is available where derivative contracts are dealt with under fair value accounting principles by the transferor company (CTA 2009, s 685). In this case, the transferor must bring into account the fair value of the asset (or liability), so the transfer may not be tax neutral. Again, in practice, this would usually mean that the derivative contract is taxed on a ‘mark-to-market’ basis and, as such, the merger itself has not technically given rise to the tax charge. Again, this provision only applies if the merger is effected for bona fide commercial reasons and does not form part of a tax avoidance scheme and a system for clearance in advance is available. There is also a regime TAAR which applies to the derivative contracts regime (see CTA 2009, s 698A et seq) which should be considered.

432

Cross-border mergers 20.39

MERGERS LEAVING ASSETS OUTSIDE THE UK TAX CHARGE TCGA 1992, s 140F: mergers outside UK tax charge 20.37 This legislation provides relief for mergers whereby chargeable assets are transferred from a UK resident company to a company that is not UK resident, where the assets concerned were used by the UK company in a business that it carried on outside the UK but in another Member State. TCGA 1992, s 140F(1) – scope of legislation 20.38 ‘(1) This section applies on a merger which satisfies the conditions specified in subsection (2), where – (a) an SE is formed by the merger of two or more companies in accordance with Articles 2(1) and 17(2)(a) or (b) of Council Regulation (EC) 2157/2001 on the Statute for a European Company (Societas Europaea), (b) an SCE is formed by the merger of two or more cooperative societies, at least one of which is a registered society within the meaning of the Co-operative and Community Benefit Societies Act 2014 or a society registered or treated as registered under the Industrial and Provident Societies Act (Northern Ireland) 1969, in accordance with Articles 2(1) and 19 of Council Regulation (EC) 1435/2003 on the Statute for a European Cooperative Society (SCE), (c)

the merger is effected by the transfer by one or more companies of all their assets and liabilities to a single existing company, or

(d) the merger is effected by the transfer by two or more companies of all their assets and liabilities to a single new company (other than an SE or an SCE) in exchange for the issue by the transferee, to each person holding shares in or debentures of a transferor, of shares or debentures.’ Analysis 20.39 This provision applies to exactly the same sort of transactions as TCGA 1992, section 140E.

433

20.40 Cross-border mergers TCGA 1992, s 140F(2) – conditions for legislation to apply 20.40 ‘(2) The conditions mentioned in subsection (1) are that – (a) each merging company is resident in a member State, (b) the merging companies are not all resident in the same State, (c)

in the course of the merger a company resident in the United Kingdom (‘company A’) transfers to a company resident in another member State (‘company B’) all assets and liabilities relating to a business which company A carried on in a Member State other than the United Kingdom through a permanent establishment,

(d)

the aggregate of the chargeable gains accruing to company A on the transfer exceeds the aggregate of any allowable losses so accruing,

(e)

in the case of a merger to which subsection (1)(a), (b) or (c) applies, either – (i)

the transfer of assets and liabilities is made in exchange for the issue by the transferee, to each person holding shares in or debentures of a transferor, of shares or debentures, or

(ii) sub-paragraph (i) is not satisfied by reason only, and to the extent only, that the transferee is prevented from complying with sub-paragraph (i) by section 658 of the Companies Act 2006 (rule against limited company acquiring own shares) or a corresponding provision of the law of another member State preventing the issue of shares or debentures to itself, and (f)

in the case of a merger to which subsection (1)(c) or (d) applies, in the course of the merger each transferor ceases to exist without being in liquidation (within the meaning given by section 247 of the Insolvency Act 1986 (c.55)).’

Analysis 20.41 The first two conditions require the merger of at least two companies that are resident in different Member States. The third condition makes it clear that one of those companies must be UK resident. The UK resident company must have a non-UK PE carrying on a business (note, not necessarily a trade) in another Member State and the assets and liabilities of that business must be transferred to the transferee company in the merger. To allow TCGA 1992, s 140F to operate in a post-Brexit environment, the words ‘Member State’ and ‘State’ in TCGA 1992, s 140F(2)(a) and (b) respectively have been replaced with ‘relevant state’. This is defined as the UK or an EU 434

Cross-border mergers 20.42 Member State and has been introduced by SI 2019/689 from the ‘exit day’ (being the day of Brexit) to allow this provision to continue to apply as before. The effect of this amendment is not intended to allow TCGA 1992, s 140F to apply to mergers with companies outside the EU. The aggregate of the chargeable gains accruing to the UK company on the transfer must exceed the aggregate of any allowable losses. This is similar to provisions like TCGA 1992, ss 140 and 140C (Chapters 27 and 28). The intention is to ensure that transferor companies cannot treat the allowable losses and chargeable gains separately. Otherwise, any allowable losses arising might be set against chargeable gains arising on disposals of other assets during the accounting period, leaving the chargeable gains on the disposal of the assets of the permanent establishment to be postponed using TCGA 1992, s 140F. Again, we have the provision that permits an upstream merger, where it would not be possible for the transferee company to issue shares to itself in its capacity as shareholder of the transferor company. We again note that this relief is mandatory. Again, there is no provision for any payment of cash as part of the transaction. This was discussed in the context of TCGA 1992, s 140E, and TCGA 1992, s 140F(2)(e) is in identical terms, so these mergers might also not qualify for relief if there is any cash element to the consideration. Finally, we have the requirement (added by the correcting regulations SI 2008/1579, as this provision was not in the 2007 regulations!) that the transferor company or companies cease to exist, without liquidation. So, again, it may not be permissible to carry out cross-border mergers by liquidation and the court ordered process of winding up without liquidation may be a necessity for mergers to qualify for relief under TCGA 1992, s 140F. TCGA 1992, s 140F(3) and (4) – mechanism for relief 20.42 ‘(3) Where this section applies, for the purposes of this Act – (a) the allowable losses accruing to company A on the transfer shall be set off against the chargeable gains so accruing, and (b) the transfer shall be treated as giving rise to a single chargeable gain equal to the aggregate of those gains after deducting the aggregate of those losses. (4) Where this section applies, section 122 of TIOPA 2010 (transfer of a non-UK trade) shall also apply.’ 435

20.43 Cross-border mergers Analysis 20.43 Where this section applies, the net chargeable gain, after deducting the allowable losses on the disposals, shall be computed and the transfer will be treated as giving rise to a single chargeable gain of the net amount. This provision then applies TIOPA 2010, s 1221 to the gain, so that double tax relief is granted on the basis of the notional tax that would have applied in the other Member State, where the SE was situated, but for the Mergers Directive. We shall see this approach in TCGA 1992, s 140C (Chapter 28) and for the same reason, to ensure the coherence of the Mergers Directive, which includes some practical guidance gained from the Brexit-driven restructuring which has sought to rely on this relief.

1 The legislation as published refers to ICTA 1988, s 815A. But this provision has been repealed and replaced by TIOPA 2010, s 122. It appears that a drafting error means that neither TCGA 1992, s 140C(5) nor TCGA 1992, s 140F(4) has been amended.

TCGA 1992, s 140F(5) – commercial and tax avoidance tests, clearances and definitions 20.44 ‘(5) Subsections (8) and (9) of section 140E apply for the purposes of this section as they apply for the purposes of that section.’ Analysis 20.45 This applies the last two provisions of TCGA 1992, s 140E to TCGA 1992, s 140F, too. Firstly, there is the same requirement for bona fide commercial reasons for the merger and for it not to have a tax avoidance purpose, and the clearance provisions of TCGA 1992, s 138 will apply to TCGA 1992, s 140F. The definitions in TCGA 1992, s 140E(9) apply to TCGA 1992, s 140F, too.

FURTHER RELIEFS FOR MERGERS THAT LEAVE ASSETS OUTSIDE THE UK TAX CHARGE 20.46 Again, the regulations introduce a series of further reliefs for such mergers, for assets that are dealt with under the different tax regimes for

436

Cross-border mergers 20.48 intangible fixed assets, loan relationships and derivatives. The legislation is at TIOPA 2010, ss 118 and 119. These provisions operate on the same transactions as TCGA 1992, s 140F, as described in TIOPA 2010, s 118, and give relief in essentially the same way, in respect of transfers of intangible fixed assets, loan relationships or derivative contracts. The overall result of the legislation is to charge only the notional tax that would have been chargeable after giving relief for the tax that would have been payable in the other Member State, but for the operation of the Mergers Directive in that other Member State (TIOPA 2010, s 119).

TREATMENT OF SECURITIES ISSUED ON MERGER – SHAREHOLDER RELIEFS 20.47 This sets out the tax treatment of the shareholders of the transferor company involved in a merger. So this is the shareholder level relief where a transferee company issues shares or debentures to the shareholders of the transferor companies in a merger. Those newly-issued shares effectively replace the shares held in the original transferor companies. To that extent, this relief is similar in intent to those given by TCGA 1992, s 135 or 136. The distributions legislation is also disapplied in some circumstances. TCGA 1992, s 140G was introduced in 2005, along with the rest of the legislation relating to SEs. It is modified by the 2007 regulations to cover issues of shares in the wider range of transactions now covered by the UK’s legislation on mergers. TCGA 1992, s 140G(1) – qualifying mergers 20.48 ‘(1) This section applies on a merger which satisfies the conditions specified in subsection (2), where – (a) an SE is formed by the merger of two or more companies in accordance with Articles 2(1) and 17(2)(a) or (b) of Council Regulation (EC) 2157/2001 on the Statute for a European Company (Societas Europaea), (b) an SCE is formed by the merger of two or more cooperative societies, at least one of which is a society registered under the Industrial and Provident Societies Act 1965, in accordance with

437

20.49 Cross-border mergers Articles 2(1) and 19 of Council Regulation (EC) 1435/2003 on the Statute for a European Cooperative Society (SCE), (c)

the merger is effected by the transfer by one or more companies of all their assets and liabilities to a single existing company in exchange for the issue by the transferee, to each person holding shares in or debentures of a transferor, of shares or debentures, or

(d) the merger is effected by the transfer by two or more companies of all their assets and liabilities to a single new company (other than an SE or an SCE) in exchange for the issue by the transferee, to each person holding shares in or debentures of a transferor, of shares or debentures.’ Analysis 20.49 These provisions operate on the same transactions as TCGA 1992, ss 140E and 140F, other than upstream mergers where no shares can be issued. Since TCGA 1992, s 140G is specifically about the shares that are issued, it would have no application to a merger without an issue of shares. TCGA 1992, s 140G(2) – qualifying conditions 20.50 ‘(2) The conditions mentioned in subsection (1) are that – (a) each of the merging companies is resident in a member State, (b) the merging companies are not all resident in the same State, and (c)

the merger does not constitute or form part of a scheme of reconstruction within the meaning of section 136.’

Analysis 20.51 The basic conditions will by now be quite familiar to readers: there must be a merger of two or more companies and each merging company must be resident in a Member State but they must not all be resident in the same state. The merger must not form part of a scheme of reconstruction within the meaning of TCGA 1992, s 136. If it did, there would be no requirement to apply TCGA 1992, s 140G, as TCGA 1992, s 136 would be applicable, instead. SI 2019/689 similarly amends TCGA 1992, s 140G(2) to allow this provision to continue to operate post-Brexit.

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Cross-border mergers 20.55 TCGA 1992, s 140G(3) – effect of legislation 20.52 ‘(3) Where this section applies, the merger shall be treated for the purposes of section 136 as if it were a scheme of reconstruction.’ Analysis 20.53

Again, this relief is mandatory, as is the relief under TCGA 1992, s 136.

Where the conditions are satisfied, the merger shall be treated for the purposes of TCGA 1992, s 136 as if it were a scheme of reconstruction. This means that the shareholders will be treated as if the shares had been subject to a reorganisation of share capital, so the shares held in the transferee company will be treated as if they were the same shares as the shares in the transferor or transferee company. Note that, although the legislation clearly applies to shareholders where companies merge under TCGA 1992, s 140E or 140F, TCGA 1992, s 140G will also apply where the merger does not have the nexus with the UK that those provisions require. So UK shareholders are protected by TCGA 1992, s 140G where there is a merger of companies that are not UK resident and that do not have UK permanent establishments. TCGA 1992, s 140G(4) – restrictions of relief 20.54 ‘(4) Where section 136 applies by virtue of subsection (3) above section 136(6) (and section 137) shall not apply.’ Analysis 20.55 This is a slightly oddly written provision. It tells us that, if TCGA 1992, s 136 applies by virtue of TCGA 1992, s 140G(2), neither TCGA 1992, s 136(6) nor s 137 (the anti-avoidance provisions) apply. However, TCGA 1992, s 136(6) merely applies TCGA 1992, s 137, so that part of the provision seems to be tautologous. That is, TCGA 1992, s 137 is disapplied in its entirety, and TCGA 1992, s 137(1) is also disapplied specifically. This is not, however, a removal of the anti-avoidance rules. Instead, TCGA 1992, s 140G(5) applies the requirements of bona fide commercial reasons and non-tax-avoidance motives from TCGA 1992, s 140E. So the impact of TCGA 1992, s 140G(3) would therefore seem to be only that shareholders with

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20.56 Cross-border mergers holdings of 5 per cent or less of the company’s issued share capital (or of any class thereof) are not automatically entitled to the relief as they would be if TCGA 1992, s 137 were to apply. TCGA 1992, s 140G(5) – commerciality and clearance 20.56 ‘(5) Subsections (8) and (9) of section 140E apply for the purposes of this section as they apply for the purposes of that section.’ Analysis 20.57 This applies the last two provisions of TCGA 1992, s 140E to TCGA 1992, s 140G, too. As mentioned above, since TCGA 1992, s 140E(8) is applied to TCGA 1992, s 140G by TCGA 1992, s 140G(5), the overall effect is that there is still a requirement for a bona fide commercial reason for the transaction, it must not have a tax avoidance motive and clearance in advance is available for these transactions. But there is no exemption from this requirement for shareholders with less than 5 per cent of the shares of any class. The definitions in TCGA 1992, s 140E(9) also apply to TCGA 1992, s 140G. Prevention of double taxation 20.58 SI 2008/1579 also added a new provision, TCGA 1992, s 140GA, to prevent a charge arising under TCGA 1992, s 24 (assets lost or destroyed) or TCGA 1992, s 122 (capital distributions). It is not clear whether this is intended to apply only to the shareholders, where TCGA 1992, s 140G is targeted, or whether TCGA 1992, s 140GA is targeted more widely, at transactions to which TCGA 1992, ss 140E and 140F apply, too. That said, if it is widely targeted, TCGA 1992, s 140E(7) would be otiose. TCGA 1992, s 140GA – disapplication of TCGA 1992, ss 24 and 122 where subsidiary merges with its parent 20.59

‘Sections 24 and 122 do not apply if –

(a) a merger is effected by the transfer by a company (‘the transferor company’) of all of its assets and liabilities to a single company that holds the whole of the ordinary share capital in the transferor company, (b) each merging company is resident in a member State, (c)

the merging companies are not all resident in the same State,

(d) section 139 does not apply in relation to the transfer, and 440

Cross-border mergers 20.63 (e)

in the course of the merger the transferor company ceases to exist without being in liquidation (within the meaning given by section 247 of the Insolvency Act 1986 (c. 55).’

Analysis 20.60 In effect, this does nothing more than we have already said above. That is, where there is a cross-border merger to which TCGA 1992, s 139 does not apply (so that the reliefs under TCGA 1992, s 140E or 140F are in point, instead), the shareholders of the transferor company shall not be charged under TCGA 1992, s 24 on the ‘loss’ of their shares in that company, and they will not be charged under TCGA 1992, s 122 as if the issue of shares by the transferee company were a capital distribution1.

1 The authors note that it is not clear why this provision is required. There is certainly no similar protection in TCGA 1992, s 139 itself, for example, and yet there has never been a suggestion that TCGA 1992, s 24 or 122 might apply to a UK domestic demerger.

DISTRIBUTIONS 20.61 In Chapter 19 we discussed at some length whether a merger involving a winding up without liquidation could be an income distribution under CTA 2010, Part 5, Chapter 2. For the purposes of cross-border mergers, this issue has been resolved by CTA 2010, s 1031: CTA 2010, s 1031 – distribution as part of a cross-border merger 20.62 ‘If (a) a company making a distribution as part of a merger ceases to exist (without being wound up), and (b) section 140E or 140F of TCGA 1992 (cross-border mergers) applies in relation to the merger, the distribution is not a distribution of a company for the purposes of the Corporation Tax Acts.’ Analysis 20.63 In contrast to the issues that were discussed in respect of domestic mergers, this provision makes it clear that we do not have to worry about distributions for cross-border mergers. Or do we? 441

20.64 Cross-border mergers CTA 2010, s 1031 only applies where the cross-border merger is one to which TCGA 1992, s 140E or 140F apply. However, some (if not most) mergers that leave assets within the UK tax charge will be relievable under TCGA 1992, s 139, and therefore TCGA 1992, s 140E will not apply, because of TCGA 1992, s 140E(2)(c). What this appears to mean is that mergers that leave assets within the UK tax charge are not exempted from the distributions legislation by CTA 2010, s 1031 so that the issues raised in Chapter 19 about domestic mergers may still apply to cross-border mergers.

OTHER CONSEQUENTIAL PROVISIONS 20.64 There are a number of other consequential changes to tax legislation to accompany these largely new provisions. In brief, these are: ●●

no tax charge arises under TCGA 1992, s 154 (replacement of business assets)where the replacement assets are transferred in a merger to which TCGA 1992, s 140E applies;

●●

ensure that no degrouping charge arises in a merger to which TCGA 1992, s 140E applies under the degrouping provisions of TCGA 1992, s 179;

●●

no balancing adjustment arises in a merger to which TCGA 1992, s 140E applies, or in a merger to which TCGA 1992, s 140E applies, or to which it would apply but for the fact that TCGA 1992, s 139 applies, instead, under the capital allowances provisions of Capital Allowances Act 2001, s 561A.

CONCLUSION 20.65 The 2005 implementation of the revised Mergers Directive with the European Company Statute generated several new reliefs specifically in relation to SEs, albeit based on the existing reliefs for reconstructions. While the enactment of the Cross-Border Mergers Directive has required further changes to the UK tax system, to permit a wider range of mergers, it is again typical of the way UK tax legislation has built up that the new rules enacted in 2007 effectively ‘piggy-backed’ on the 2005 changes. This is one of the themes of this book, how legislation originally enacted for one purpose is often modified or extended to fulfil a wider purpose. Also, in going through the new legislation in detail, there are a number of changes that appear to be unnecessary. However, the November 2006 Consultation Document, stated that: 442

Cross-border mergers 20.67 ‘the Government did consider the possibility that existing tax legislation, particularly that relating to company reconstructions, might in any case apply to cross-border mergers involving UK companies. This might be a tenable view for some such mergers, but not for all. The potential for uncertainty to adversely affect those contemplating cross-border mergers has however caused the Government to decide that amendment of the bespoke rules put in place for mergers to form SEs is the most effective manner in which to legislate.’ That said, we have also pointed out a number of anomalies in both the UK situation and in the implementations of the EU Directives. Perhaps this is one of those occasions when it would have been better to have rewritten the legislation on mergers, so that the same reliefs apply in the same way and to the same persons in both domestic and cross-border transactions.

STAMP TAXES 20.66 SDLT is charged on transfers of land located in England and Northern Ireland, LTT in Wales and LBTT on land in Scotland. In all cases, the location of the transferor and transferee are not relevant. Therefore, the fact that a transaction may involve non-UK companies and cross-border transfers has no effect on any charges. In principle, the same is true for stamp duty charges. However, it is interesting to note that, for SDRT purposes, the shares of an SE are chargeable securities only while the SE maintains its registered office in the UK. It is therefore possible to remove the shares from the charge to SDRT (and therefore from any practical need to worry about stamp duty on those shares) by moving its registered office out of the UK.

VALUE ADDED TAX 20.67 The first step for VAT is to look at each transferor company and ascertain where the business or businesses are that the transferor is transferring. Sometimes it will be in the UK and, if the business is the making of taxable supplies, the transferor will be registered for UK VAT and the transferee will, if it is not already registered for UK VAT, become registrable for UK VAT as a result of the exercise. If and to the extent that the exercise consists of the transfer of goods situated in the UK and of the provision of services (eg the transfer of IP rights) to a 443

20.67 Cross-border mergers transferee with a business establishment or other fixed establishment in the UK, ordinarily it will be a TOGC under the UK TOGC rules, for which see 3.12, 3.13. Remember that, if the transferor is UK VAT registered, for the exercise to be a TOGC the transferee must either be already UK registered, or become compulsorily registrable, or be accepted by HMRC before the transaction for voluntary registration. However, other countries’ VAT rules may also be relevant. A transferring company may carry on a business, or even all its business, in another country, inside or outside the EU. There the first step is to see whether that country levies a VAT or similar tax. If it does, the next question to see is whether it has a TOGC rule. The EU Directive does not require EU countries to have a TOGC rule, and some EU countries do not. If there is a TOGC rule its provisions need to be examined carefully to see whether the proposed transaction falls within them – TOGC provisions vary. If and to the extent that the country levies a VAT but the transaction does not count as a TOGC, it will involve actual supplies of goods and services which will attract the VAT of the relevant country, except to the extent that they are exempt or zero-rated. If the business makes wholly or partly taxable supplies for VAT the transferee will seek a refund of the relevant input VAT on general principles. Sometimes things may be a bit more complicated than this, for example, the business may have some assets in the UK or in a third country. See 27.63 and 28.32. The transferee company makes no supply as part of the transaction; it issues shares or debentures and, as we have seen, on general principles this is not a supply. Any input VAT which it incurs in connection with the exercise will be input VAT related to the activities of the business that it acquires. As to the position of the shareholders in the transferor company, who become shareholders in the transferee, the first question, as always, is whether they are carrying on a relevant business in relation to their holding. If they are, the next question is whether the exercise constitutes a supply by them. The discussion at 18.8 is relevant here. We think the better view is that they make no supply, and any supply by them is general overhead. If they do make a supply, it will be exempt, as being in substance a disposal of their shares, but in some cases it will be possible to argue that any costs incurred by them are attributable to their continuing business and general overhead for that reason, see 8.24.

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Part 6

Demergers

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Chapter 21

Introduction to demergers

INTRODUCTION 21.1 This Part of the book is about demergers: what a demerger is, structures for carrying out demergers and the tax consequences of using those structures. We will look both at the tax costs and at the reliefs or exemptions available and, in particular, we will look in detail at a specific exemption for a specific type of demerger frequently referred to as a ‘statutory demerger’. We will not, however, be using this entirely misleading phrase, as, to us, it suggests that other structures are somehow non-statutory and hence unlawful! We will also look at the way in which the other reliefs available assist with the tax efficiency of demergers, despite the fact that those reliefs, mainly those at TCGA 1992, ss 136 and 139, were designed for different scenarios when they were introduced in 1962 and reused in 1965. We will demonstrate, once again, how the evolution of commercial law and business practices have forced further evolution of the tax code and also how the tax code has adapted pre-existing concepts and mechanisms for those new commercial and business practices.

WHAT IS A DEMERGER? 21.2 A good starting point is to define a ‘demerger’ in terms of what it means commercially, ie what does a business person mean when he or she uses the word? The word itself seems to have arisen during the late 1970s to describe this type of transaction and is, perhaps, a somewhat clumsy word1. Indeed, in the Inland Revenue Press Release dated 20 June 1980 – unveiling the legislation that is now CTA 2010, Part 23, Chapter 5 – the then Chancellor of the Exchequer apologised ‘for that word which has now become part of the jargon’. In fact, tax legislation generally refers to a ‘division’, never to a ‘demerger’. There is no statutory definition of the word ‘demerger’ but it clearly has the flavour of ‘unmerging’ something that has previously been merged or

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21.3 Introduction to demergers of separation. At its simplest, a demerger might be defined commercially as involving the separation of the activities of a company or of a group of companies, but there must be more to it than that or the mere separation of business activities, even by direct sale, would be a demerger too. So there is another leg to a demerger; the separation is carried out in such a way that the separated businesses are each controlled by some or all of the shareholders of the original amalgamated business. A demerger is not effected by the sale of non-core businesses to third parties. Either the activities are split up so that the two separated businesses are controlled by the same shareholders in the same proportions as the amalgamated business was, or the split is of both businesses and shareholder groups so that one shareholder group takes one part of the business and the other takes the other. This, of course, also reflects some of the commentary about reconstructions (Chapters 15 and 16), which goes some way to explaining why demergers are dealt with as reconstructions for tax purposes. The third part of our definition is that the business separation is carried out in such a way that there is no consideration payable by the shareholders to the company which is demerging its business or businesses, or vice versa. Demergers are not effected by selling part of the business to the shareholders, they are effected by giving the business to the shareholders. How this can be done legally is discussed further below. For tax purposes, demergers are a corporation tax matter. So while the splitting of a partnership might be a demerger when considering our three-legged definition, for the purposes of this book and for the purposes of the corporate tax reliefs available, we are only looking at transactions where both the original and the demerged businesses are carried on in a corporate vehicle.

1 Compared to the EU Directives which refer to divisions and partial divisions.

WHY DEMERGE? 21.3 Business, like many other fields of human endeavour, appears to be susceptible to fashions. Sometimes the fashion appears to be for businesses to amalgamate or merge to create commercial behemoths with a very wide variety of activities. The motto during these periods of amalgamation appears to be ‘big is beautiful’: in the 1980 Press Release referred to above, the Chancellor referred to ‘the fashion for industrial elephantism’. At other times, the received wisdom is that it is better to have smaller business units concentrating on one, or just a few, closely related core activities.

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Introduction to demergers 21.3 There are many commercial reasons given for this form of corporate downsizing. In our experience, these are usually based on the ability of management to focus on a single core business rather than on a series of unrelated businesses with commensurately different strategies. Excess diversification can cause problems in the cost of borrowing with rates of finance based on the ‘highest common denominator’, which is the rate applicable to the highest risk business in the group, or at least on a mixed rate, as such lending is usually subject to cross-guarantees from all group companies. Other reasons may include a desire to spin off a new start-up business to insulate the core activities from the new high-risk activity. Whatever the reason for breaking up the large groups, the challenge is how to get from one huge, diversified commercial giant into two or more small, tightly focused and efficient commercial pygmies. Another major reason for demerger, in our experience, relates largely (but not exclusively) to private companies where shareholders can either fall out on a personal level or merely have irreconcilable differences as to the best way to run the business going forward. In either case, disputes at board level or at shareholder level – and with smaller private companies these are often indistinguishable – lead to loss of focus on the business. Either the disparate groups of shareholders are pulling in different directions at board level, so that any semblance of business strategy gets forgotten, or a smaller group of dissident shareholders is able to muster sufficient votes to block decisions at shareholder level leading to board time being spent allaying shareholder concerns or focusing on ways to minimise shareholder activism. Again, in this scenario, it is the business that suffers. In circumstances such as these, it is not so much the separation of the business that is paramount as the separation of the shareholders or the shareholder groups. So, we have seen a number of reasons why a company might want to separate its business activities either per se or as part of a wider segregation of shareholder groups, but why carry out a demerger rather than a sale of the noncore activities? Invariably, there are a variety of detailed reasons why any given demerger is proposed or carried out. There is no single answer to this question, but we set out below a couple of relatively common scenarios. Where it is a question of separating a large industrial conglomerate into its component parts, it is reasonable to suppose that the shareholders of such a conglomerate should be given the choice as to whether they continue to invest in each of the component parts going forward or decide to sell their shares in some or all of those component parts after the demerger. Typically, for example, looking at the separation of large, often quoted, groups, the business activities will be separated into two or more entities each owned by the same shareholders in the same proportion as they held shares in the original, predemerger entity. The shareholders are then free to hold onto their shares in 449

21.3 Introduction to demergers both/all of those entities or to sell all or some of them. Take as an example the Hanson group which, in the mid-1990s, decided to separate into four main groups: Millennium Chemicals, Imperial Tobacco and the Energy Group, leaving the original Hanson as a building materials group. Following the three demergers, Hanson plc shareholders now also held shares in the three other groups and were free to trade those shares as they wished. It might, of course, have been possible for Hanson to dispose of any one or more of the businesses by way of sale, but there are a number of reasons why this might not have been possible: ●●

each of the businesses demerged was worth £2 billion or more. The market for businesses of that size, particularly 10 years ago, was extremely limited, so would there have been a buyer for all or any of the businesses?

●●

even if there had been such a buyer, what would the Hanson group be able to do with the money? This sort of sum would inevitably be far in excess of the working capital requirements of the group and even if debt repayment were an option, most groups prefer to retain a moderate level of debt funding on the basis of the old axiom that it is better to spend someone else’s money than your own;

●●

having just demerged in order to tighten the focus of the business onto one core business, the only possible reinvestment would logically be into a similar type of business, but £2 billion businesses available to buy tend to be quite thin on the ground;

●●

alternatively, Hanson might have returned the money to shareholders by way of dividend, but returning cash to shareholders in this way would not have been particularly efficient, particularly in tax terms. The disposal would have been chargeable to corporation tax on chargeable gains (because the transaction pre-dated the substantial shareholding exemption) and a dividend would have been chargeable to tax on the shareholders, as well as carrying an ACT cost to Hanson.

In contrast, a demerger, using the available tax reliefs that we will be discussing in this Part, allowed the shareholders to receive shares in the three new groups in a tax-free form (tax-free to both them and to Hanson), as well as retaining their original holdings in Hanson plc. The shareholders were then free to sell or keep any of their holdings as they wanted, with tax only being suffered once, at the point of disposal of the demerged shareholdings. Let us turn now to the smaller, private company, perhaps established three or four generations ago. The shares are more or less all in the hands of a relatively small number (typically less than 250) of members of the same family covering two, three or four generations. It is not uncommon for the shareholders to split 450

Introduction to demergers 21.4 into different groups with different interests within the wider business context of the family company. Selling one of the businesses to a third party would not separate the shareholder groups and would instead leave both groups with only one business to run. Selling part of the business to one of the groups would be more difficult than it first appears. First, the purchaser shareholders would have to raise money to buy the business and they would have to finance the debt and, secondly, because they would still be shareholders of the original company, they would expect some return from the profit on sale of the business. And, of course, this doesn’t actually achieve the commercial aim of separating the business between the different shareholder groups. Clearly, therefore, the commercial answer to the problem is a direct separation of the business, this time with segregation of the shareholder groups, so that each group can run their business in their way; without having to consider the other group. And similar reasons apply to the separation of business of companies with very few shareholders. A two-man company, for example, is most easily split by demerger, rather than each shareholder buying half the business from the other.

CONCLUSION 21.4 In summary, we have seen that a demerger has the following characteristics: ●●

it is a commercial separation of the businesses carried on by a company or group of companies so that the demerged businesses are carried on by two or more companies or groups;

●●

the shareholders of the demerged entities are essentially the same, taken together, although demergers can be carried out in such a way as to segregate the shareholders;

●●

no consideration is given to the distributing company for the demerger;

●●

the demerger can be driven by a variety of commercial needs.

We will now go on to review the legal bases for demergers and the tax reliefs relied upon, before reviewing the various structures used and the way the available tax reliefs and exemptions are used.

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Chapter 22

Demergers: legal background

THE LEGAL BASIS FOR A DEMERGER 22.1 Looking back to our definition of a demerger, we find that apart from segregating the businesses into separate companies or groups, but retaining the overall shareholder base, a demerger is a transaction carried out for no consideration when looking at the transaction from the demerging company’s perspective. The business to be demerged is effectively given away by the original parent company or group. For this reason, demerger mechanisms have inbuilt protections for both members and creditors in company law. In addition, one of the most fundamental provisions of corporate law is that a company will maintain its capital and accordingly shall not give assets away other than out of distributable reserves or in accordance with the specific provisions of CA 2006. In the previous Part, we looked at the legal ways in which a company can lawfully give away its assets for no consideration. These are: ●●

a distribution in specie;

●●

a liquidation;

●●

a reduction of capital.

Each of these mechanisms can be, and have been, used to facilitate a demerger, the first two being the most common. We will explore each type of demerger in more detail later in this Part, but first we will look at the typical structures and the main tax reliefs relevant to this sort of transaction. Before that, however, we need to look at our old friend, dissolution without winding up.

DISSOLUTION WITHOUT WINDING UP 22.2 We have seen that a dissolution without winding up is a possible mechanism for company mergers, under UK company law. Is this also a lawful mechanism for demergers of UK companies?

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Demergers: legal background 22.2 Let us remind ourselves of the words of Companies Act 2006, s 900(1)(a) and (2)(d) (see Chapter 17): ‘(1) This section applies where application is made to the court under section 899 to sanction of a compromise or arrangement and it is shown that – (a) the compromise or arrangement is proposed for the purposes of, or in connection with, a scheme for the reconstruction of any company or companies, or the amalgamation of any two or more companies,’ ‘(2) The court may, either by the order sanctioning the compromise or arrangement or by a subsequent order, make provision for all or any of the following matters. … (d) the dissolution, without winding up, of any transferor company;’ CA 2006, s 900(1)(a) refers to ‘a scheme for the reconstruction of any company or companies’. So the first question we need to answer is whether a demerger is a scheme of reconstruction. This was discussed in some detail in Chapter 15, where we saw Buckley J’s comment in South African Supply1, that a scheme of reconstruction requires that ‘substantially the same business be carried on and substantially the same people shall carry it on’. In the later Brooklands Selangor case2, Pennycuick J confirmed that this meant that a demerger was not a scheme of reconstruction for company law purposes: ‘That, I think, involves a substantial alteration in the membership of the two companies within the meaning of the passages I have quoted from the judgments of Chitty and Buckley JJ. It seems to me that that transaction is not a reconstruction and that a transfer made pursuant to that transaction falls neither within the letter nor within the intent of section 55’. In that particular case, the reason given was that there had been a ‘substantial alteration in the membership of the two companies’, so the demerger could not fit into Buckley J’s definition. This was also subsequently confirmed in Re MyTravel Group [2004] EWHC 2741 (Ch), which also confirmed that substantially the same people must carry on, and hence own, the business before and after the demerger, ie there must be a ‘substantial common identity’. The clear implication of this is that the partitioning of the business activities is not as relevant, so that it is possible for a demerger to be a scheme of reconstruction for company law purposes, if both (or all) successor companies have the same shareholders. As we have seen, Park J in Morgans Executors v Fellows3 took the same view, that the segregation of the shareholders was what determined that a demerger was not a scheme of reconstruction. 453

22.3 Demergers: legal background On that basis, we conclude that a demerger where the shareholder base is partitioned is not a scheme of reconstruction for company law purposes, so that the court cannot make provision for a ‘dissolution, without winding up, of any transferor company’ under CA 2006, s 900(2)(d). However, a business separation where the successor companies are both owned by the same shareholders can be a scheme of reconstruction. Many public company demergers in the 1990s were of this kind, such as the three Hanson demergers and the spin-off of Centrica from British Gas, so these demergers were schemes of reconstruction by this analysis and could have been carried out using the predecessor legislation to CA 2006, s 899, obtaining a court order for a ‘dissolution, without winding up, of any transferor company’.

1 Re South African Supply and Cold Storage Co [1904] 2 Ch 268. 2 Brooklands Selangor Holdings Ltd v IRC [1970] 2 All ER 76 (see Chapter 15). 3 74 TC 232 (see Chapter 15).

INTERACTION WITH EU LEGISLATION1 22.3 We have previously looked at the Sixth Company Law Directive on demergers2 in Chapter 4 (as noted, the Directive and other EU legislation generally refers to ‘divisions’ or ‘partial divisions’, rather than to ‘demergers’). This provides certain protections for the members and creditors where public companies are divided. A division is defined as ‘the operation whereby, after being wound up without going into liquidation, a company transfers to more than one company all its assets and liabilities in exchange for the allocation to the shareholders of the company being divided of shares in the companies receiving contributions as a result of the division …’ (Articles 2(1) and 21(1)). Putting this together with the previous section, it is clear that demergers by winding up without liquidation can only be carried out in the UK where the demerger would be a scheme of reconstruction, ie where the business is split but the shareholders are not segregated. So, the protections afforded to members and creditors of public companies by the Sixth Directive can only apply in the UK to those transactions that are schemes of reconstruction. But most of the major public company demergers that we have worked on do not segregate the shareholders, so the Sixth Directive protections could have applied to those demergers, had they been carried out by dissolution without winding up. However, since most of them were carried out by exempt distribution (Chapter 24) or by return of capital (Chapter 25), the Directive protections would not have been in point. 454

Demergers: legal background 22.5 However, we also noted in Chapter 4 that the Directive can provide that division by acquisition or by formation of new companies may also be effected where the company being divided is in liquidation, provided that this option is restricted to companies which have not yet begun to distribute their assets to their shareholders (see Articles 2(2) and 21(2) of the Sixth Directive). So the Directive may apply to public company demergers by liquidation (see Chapter 23). It is only in liquidation distributions that the distributing company ceases to exist as a result of the demerger transaction. In demergers by distribution in specie (Chapter 24) or by return of capital (Chapter 25), the distributing company continues to exist3, so the Sixth Directive protections cannot apply to these demergers. This suggests that the Sixth Directive was largely irrelevant in the UK. Certainly, our experience with public company demergers is that very few have been carried out through the liquidation route, at least not since the exempt distributions legislation was introduced in 1980 (see Chapter 24). This means that the Sixth Directive has had no bearing on public company demergers and so was irrelevant to the shareholders of those companies.

1 As previously noted, EU legislation will continue to apply after Brexit, unless and until any changes are made by domestic legislation. 2 Sixth Council Directive 82/891/EEC of 17 December 1982 concerning divisions of public limited liability companies. 3 As we saw in Chapter 4, these transactions are referred to in EU legislation as ‘partial divisions’.

DEMERGER STRUCTURES 22.4 The one common feature of the three legal mechanisms referred to above is that they are all usually used as methods of returning funds to the shareholders of a company, not as demerger mechanisms. Furthermore, as we have seen, a demerger requires that the business activities of a company or group be segregated into two or more companies or groups, each owned by some or all of the shareholders of the original company or group.

Direct demergers 22.5 Whilst, for corporate law purposes, assets may be distributed in specie to the shareholders of a company, so that the shareholders themselves hold the legal title to the assets, this would not satisfy our definition of a demerger, which requires the assets to be divided into successor companies. So here, we are looking at the direct distribution of a subsidiary company to the shareholders of the distributing company, as described at CTA 2010, s 1076 455

22.6 Demergers: legal background (see Chapter 24). Figure 22.1 shows a direct demerger of a subsidiary to its ultimate shareholders. In Figure 22.1(a), they all hold shares in the subsidiary. In Figure 22.1(b), the shareholder pool is segregated too. Figure 22.1(a)

Figure 22.1(b)

Indirect demergers/three-cornered demergers 22.6 This is achieved by carrying out the transfer of a business or subsidiary to the shareholders in an indirect fashion. Essentially, the shareholders set up a new company. The transferor company then declares a dividend which is satisfied by the transfer of the business or subsidiary to be demerged to the transferee (new) company and the transferee (new) company issues shares to the shareholders of the transferor company in consideration. As we shall see, these mechanisms can be schemes of reconstruction, as defined at TCGA 1992, Sch 5AA, so that the reliefs from tax appropriate to reconstructions can apply.

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Demergers: legal background 22.6 Figure 22.2 shows the structures typically seen in an indirect demerger are of the following types. In Figure 22.2(a), the shareholders all retain an interest in both companies. In Figure 22.2(b), the shareholder pool is segregated. Figure 22.2(a)

Figure 22.2(b)

We see from these that, while there is a wide variety of structures for demergers, they all have in common the key features that we have already discussed: ●●

a separation of the businesses of a company or a group;

●●

the successor businesses are in corporate vehicles;

●●

no consideration is given to the distributing company for the demerger.

The overall group of shareholders is unchanged, although the business units may have been separated to different groups of shareholders.

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22.7 Demergers: legal background

Choice of demerger structures 22.7 Clearly, the direct demerger structure is by far the simplest approach, particularly if it can be carried out by way of a distribution in specie. However, historically, this approach has not been popular as there was no relief from the capital gains charge that would arise on the disposal of the subsidiary to the shareholders, which is clearly other than at arm’s length. Now that the substantial shareholding exemption (TCGA 1992, Sch 7AC) has been enacted, the direct route is likely to prove more popular. However, there are practical difficulties with this approach, particularly in terms of simple numbers of shares. To take an example, if the holding company has three equal shareholders and a subsidiary that has 100 £1 issued shares is to be distributed to them, how are the 100 £1 shares to be allocated among the three shareholders? This issue is demonstrated in Figure 22.3, where 100 shares of the subsidiary are to be transferred to the three equal shareholders. A direct demerger cannot work, as 100 shares cannot be divided by three. It is technically possible for all 100 shares to be held equally in joint names, but this is often not commercially desirable. However, using an indirect demerger allows New Co to issue the right number of shares to each shareholder. Figure 22.3

Similarly, with a public company demerger, the transferee company would be able to issue shares up to the value of the shares transferred to it, giving it a much more sensible capital base and also permitting shares to be issued pro rata to the distributing company’s shareholders. Consider also a demerger involving a public company with several million shareholders. Even if the sub-holding company to be demerged has a very substantial issued share capital, it is unlikely that the number of shares will be precisely the number required to give each shareholder of the holding company the appropriate number of shares pro rata in the newly distributed subsidiary unless a lot of preliminary work is done to make it so1. 458

Demergers: legal background 22.7 Another common situation is where the subsidiary or sub-group to be demerged is worth a considerable amount. It may be considered inappropriate for a company worth, say, £1 billion to have only £100,000 share capital, for example. Indeed, given that a public company demerger involves listing the newly demerged subsidiary, it would almost certainly be a commercial (or sometimes regulatory) requirement that the company’s issued share capital be somewhat closer to its market value. In these cases, the more appropriate route is the indirect demerger. This is because, in an indirect demerger, there will be a transferee company issuing shares to the shareholders of the transferor company. This means that, subject to the company law requirements that shares cannot be issued at a discount and that a public company cannot issue shares for non-cash consideration (assets or shares in another company) without such consideration having been valued, the transferee company can issue consideration shares up to the value of the assets or shares received. Direct demergers will, however, remain a useful tool where these numerical issues are not a concern, such as, for example, the subsidiary is to be distributed to a single shareholder. Another reason for using the indirect demerger is for the demerger of a business, rather than a company. Here, we need a mechanism whereby a distribution purportedly to shareholders actually puts the demerged business into a corporate vehicle (see Figure 22.4). In an indirect demerger, the shareholders set up a new company, the transferor company declares a dividend which is satisfied by the transfer of the business to be demerged to the transferee (new) company and the transferee (new) company issues shares to the shareholders of the transferor company in consideration. Figure 22.4

1 We have been through this process with a direct demerger by a listed group and it was not an easy process.

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22.8 Demergers: legal background

DIRECT DEMERGERS Are direct demergers schemes of reconstruction? 22.8 Let us look first at direct demergers. As shown above, in a direct demerger, a subsidiary or a business is passed directly to the shareholders of the parent by distribution in specie of profits or in liquidation or as consideration for a reduction of capital. We must first ask whether such a transaction is a ‘reconstruction’ under the old company jurisprudence or under the new statutory definition of TCGA 1992, Sch 5AA. To take the easy part first, the first condition of TCGA 1992, Sch 5AA requires an issue of shares for a transaction to be a scheme of reconstruction. Clearly, direct demerger structures do not involve any issue of shares, so under modern tax legislation a direct demerger is not a scheme of reconstruction. Perhaps this provides us with a clue as to the rest of the answer. If a direct demerger was a form of reconstruction under the old company jurisprudence, the Inland Revenue law makers would have ensured that it was so under the new legislation. After all, we were specifically told at the time that TCGA 1992, Sch 5AA was intended to put the previously understood meaning of ‘scheme of reconstruction’ on a statutory footing. So, clearly, the Revenue did not think that direct demergers were (or should be) schemes of reconstruction. Of course, to answer the question properly, we should go back to first principles. What is a scheme of reconstruction and is a direct demerger such a scheme? Readers are reminded of the dictionary definitions: ‘the action or process of reconstructing, rebuilding or reorganising something’ and to ‘construct, build for or put together again’ (authors’ italics). It is this latter phrase that comes closest to the meaning that might be most appropriate for company reconstructions, the putting together again of the company or its business. Does a direct demerger require ‘the putting together again of the company or its business’? Not in the opinion of the authors. Nothing in a direct demerger has the flavour of any form of reconstruction or, indeed, reorganisation. It is just a particular form of disposal by a company of one or more subsidiaries or businesses to its shareholders.

Tax consequences of direct demergers 22.9 Without any tax reliefs, direct demergers would be expensive transactions in tax terms, even today, but more so in 1980, when the relieving legislation was enacted, as companies had to account for advance corporation tax (ACT) on dividends and other distributions. We will now have a brief look at the different types of direct demerger to demonstrate this and to show how

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Demergers: legal background 22.10 the reliefs that are available now apply. These transactions will be discussed in more detail later in this chapter. We do not consider the distribution in specie of a trade or other activity directly to shareholders, as no tax reliefs exist for such transactions.

Direct demerger by distribution in specie 22.10 The simplest transaction is where a company transfers the shares of a subsidiary directly to the shareholders as in Figure 22.1(a). This could be by way of a distribution in specie of the shares or as a capital matter (return of capital or liquidations). Looking at the company’s position, first of all, we clearly have a disposal of a subsidiary for capital gains purposes. Since there is no consideration received by the distributing company, this would be a disposal by the distributing company ‘otherwise than by way of a bargain made at arm’s length’ (TCGA 1992, s 17(1)(a)). As a result, TCGA 1992, s 17(1) would deem the disposal to be for an arm’s-length consideration, market value, with an appropriate chargeable gain being computed accordingly. Without a relief from corporation tax in these circumstances, a company would be unable to carry out a demerger without incurring a substantial tax charge. This has been less of a concern since FA 2002, on the basis that the substantial shareholding exemption is very likely to apply to a disposal structured as a distribution in specie. As we shall see in Chapter 24, one of the main conditions for a demerger by distribution in specie to be an exempt distribution is that the transaction must involve a separation of trading activities. In practice, therefore, direct demergers only involve the distribution in specie of a trading subsidiary or sub-group, so the SSE would normally apply to exempt any gain accruing to the distributing company. The other problem for the company used to be the charge to ACT that required companies to pay ACT at the lower rate of corporation tax in respect of any distributions made, a charge that was repealed in 1998. While this ACT could theoretically be set off against the corporation tax due on profits, it still had the cash flow consequences of being an advance payment of tax. And the practical reality was that not all ACT could be set off against mainstream corporation tax liabilities. Indeed, the very nature of demerger transactions was such that the market value of the assets distributed were large in comparison to the company’s normal taxable profits, so the amount of ACT to be paid might take years to claw back against mainstream corporation tax liabilities or might never be recovered at all.

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22.10 Demergers: legal background For the shareholders, a distribution in specie of the shares of the subsidiary would be treated the same as any other distribution of profits: it would be chargeable to income tax under ITTOIA 2005, s 383, the charge being based on the market value of the shares transferred. This means that, absent a specific relief, shareholders might be subject to large income tax charges with no cash dividends to fund the tax bill (a ‘dry’ tax charge). While it would then seem logical, and fair, that the shares in the subsidiary now received by the shareholders should have market value base cost in respect of any future disposals, there is no legislative support for the proposition that the shares should assume a new base cost related to the amount charged as a distribution. Indeed, the authors have seen a Counsel’s Opinion that agrees that there is no provision to enhance the base cost of the shares distributed. The base cost of the transferor company is therefore assumed to remain unchanged, absent any statutory provisions to the contrary, as the transaction is neither a reorganisation nor a reconstruction. Clearly, the distribution regime was a major barrier to carrying out demergers by what is otherwise the simplest route and the government of the day realised this and enacted the FA 1980 regime that is with us today as CTA 2010, Part 23, Chapter 5. So, with the changing pattern of commercial activity, the fact that distributions in specie became a desirable method of demerging necessitated a specific and highly-targeted tax relief. Although the shareholder tax charge on distributions was also a potential barrier to these transactions, the authors consider that the ACT charge on companies was the major driver for the introduction of this new relief. The interesting historical quirk here is that the abolition of the ACT charge on companies has reversed this situation, so a relief primarily intended to benefit distributing companies now primarily benefits the shareholders. The 1980 regime treats direct demergers (and indirect demergers) by this route as not involving distributions for any purposes of the Taxes Acts. This resolved the concerns about ACT for the company and income treatment for the shareholders. The legislation also decreed certain specific treatments for the shareholders. First, since the distribution was not an income distribution, the new legislation had to ensure that it did not become a capital distribution treated as a capital gain by the shareholders (‘any distribution from a company, including a distribution in the course of dissolving or winding up the company … except a distribution which in the hands of the recipient constitutes income for the purposes of income tax’, TCGA 1992, s 122(5)(b)). So there is provision in TCGA 1992, s 192 that such exempt distributions are not capital distributions.

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Demergers: legal background 22.11 Secondly, to resolve the base cost issue, TCGA 1992, s 192 decrees that the transaction be treated as a reorganisation of share capital for the shareholders. As a result, the original base cost of the investment in shares of the transferor company is split between those shares and the shares now held in the subsidiary that was distributed (and the allocation of base cost will follow the rules in TCGA 1992, s 129 or 130, as appropriate). Otherwise, as noted above, there would be no shareholder-level relief.

Direct demerger by other mechanisms 22.11 What if a direct demerger transaction is not carried out as a distribution in specie, but is instead a distribution on liquidation or a return of capital? For the distributing company, the tax consequences of disposing of the shares of a subsidiary are the same as described above. However, a company using one of these other mechanisms may not be distributing shares in a trading company or sub-group, as the tax reliefs for these demerger mechanisms do not require the company that is being distributed to be a trading company. So, the SSE may not apply and the company would be treated as making a disposal of a subsidiary for chargeable gains purposes. Corporation tax would be charged as if this had been a transaction at arm’s length. For the shareholders, a distribution in a liquidation would be a capital distribution. The traditional view is that this is treated, by TCGA 1992, s 122(1) and (5), as a part disposal of their shares in the distributing company. So they would be subject to a dry charge to capital gains tax on the value of the shares received, less any appropriate base cost. (In the alternative view discussed at 23.13, CTA 2010, s 1030 tells us that a distribution in a winding up is not a distribution for the purposes of the Corporation Tax Acts, which means it cannot be a distribution for the purposes of TCGA 1992, s 122. Nevertheless, a distribution in a winding up may create a chargeable gain under TCGA 1992, s 24, capital sums derived from assets, as is clearly permitted by CTA 2009, s 931RA.) If the transaction is a reduction of capital, the shareholders would be treated as receiving a repayment of capital subscribed, up to the nominal capital and share premium. This would not be a distribution – by CTA 2010, s 1000(1)B – and may not generate a capital gain, as the return would only be the amount subscribed. Obviously, if the shares were acquired for a lower amount, there will be a gain and there is no relief from capital gains tax for such a gain, as this is not a scheme of reconstruction, as noted above. To the extent that the value of the shares received exceeds the capital subscribed for the shares that are cancelled, CTA 2010, s 1000(1)B would deem the excess to be a distribution. This might be susceptible to relief under the exempt 463

22.12 Demergers: legal background distributions rules, as these only refer to a ‘distribution’, without any further definition, so we assume the rules to theoretically apply to anything that is a distribution within CTA 2010, s 1000. However, if the distribution does not satisfy the detailed conditions for treatment as an exempt distribution, the shareholders will have to suffer an income tax charge at the appropriate rate.

Conclusion 22.12 In conclusion, direct demergers under the distribution in specie route have become more popular, particularly with private companies, but the numerical constraints discussed earlier in this chapter will still mean that these transactions are comparatively rare for larger public companies. For transactions that do not qualify for the exempt distribution route – non-trading groups, liquidations or returns of capital – it is assumed that such transactions will continue to be as common as hens’ teeth.

STAMP TAXES AND DIRECT DEMERGERS 22.13 In a direct demerger the shareholder receiving the demerged shares pays no consideration, so no stamp duty will arise. However it will be important to check that the demerged company (together with any subsidiaries) does not hold any UK land which has been transferred with the benefit of SDLT, LTT or LBTT group relief within the preceding three years (see Chapter 2).

INDIRECT DEMERGERS Are indirect demergers schemes of reconstruction? 22.14 We should ask the same question about indirect demergers as we did about direct demergers. In an indirect demerger, a subsidiary or trade is passed indirectly to a company that issues shares to the shareholders of the transferor company. Again, the legal mechanism can be by distribution in specie of profits or by liquidation or as consideration for a reduction of capital. Is such a transaction a ‘reconstruction’ under the old company jurisprudence or under the new statutory definition of TCGA 1992, Sch 5AA? In this context, demergers are an interesting case study for the history of taxation; on the one hand, transactions similar in structure to those now used to facilitate demergers – the donation of assets by one company to another with 464

Demergers: legal background 22.14 commonality of shareholders – have been around for a very long time, but the earliest commercial cases in this area, Hooper v Western Counties & South Wales Telephone and South African Supply and Cold Storage, were concerned with amalgamations and reconstructions, not with business partitions or demergers. As we have seen, those cases established that a reconstruction requires ‘that substantially the same business shall be carried on and substantially the same persons shall carry it on’ and in the Brooklands Selangor Holdings case a business partition (or demerger), where different shareholder groups owned the successor companies, was considered not to be a reconstruction for company law purposes. However, we can take a further inference from this case and also from a careful reading of the South African Supply and Cold Storage case. In essence, where those cases referred to a need for ‘substantially the same business’ to be carried on, the fact that the original business might be split up and carried on by one or more successor companies was considered to satisfy that criterion. What caused the problem in Brooklands Selangor Holdings was that the original shareholder group split, so that some shareholders remained shareholders of Brooklands Selangor Rubber and others became shareholders of Brooklands Selangor Holdings. It was this alteration in the membership of the two companies that was held not to be ‘substantially the same persons’ carrying on either of the successor businesses. From this, we infer that a business partition where the business is split between different successor companies, but each of those successor companies has ‘substantially the same’ shareholders as each other and as the transferor company, is a scheme of reconstruction within the meaning developed by company law cases. However, business partitions where the shareholder base is also segregated or partitioned between the successor companies, as in the Brooklands Selangor Holdings case, are not schemes of reconstruction for company law purposes. Indeed, there might even have been a problem with non-partition demergers. If a business is demerged to the shareholders so that each new entity has the same shareholders, it is clear that the shareholders remain the same in each case, but is it necessarily true to say that ‘substantially the same business’ is being carried on? There are bound to be cases where the demerged businesses are not the same as the original business. Consider, for example, a brewer that brews beer, bottles it and sells it. If the brewing trade were to be demerged, it is likely that the bottling and selling activities would be considered to be a different trade from that being carried on before (on the authority of Gordon & Blair Ltd v CIR (1962) 40 TC 358). So even a non-partition demerger might fail the South African Supply & Cold Storage test of being a reconstruction. As a result, the tax reliefs for reconstructions were not always available for business partitions, as we have seen. To give relief for such transactions, the 465

22.15 Demergers: legal background Revenue was forced to relieve demergers by concession through the 1975 Press Release and the 1985 Statement of Practice, before eventually introducing a definition of ‘reconstructions’ – for corporation tax purposes only – that encompassed business partitions, such as that in the Brooklands Selangor Holdings case. Now that there is a statutory definition of a reconstruction, HMRC is able to ensure that the definition is wide enough to encompass both business partitions and segregation of shareholder groups. Nevertheless, there is a certain irony that capital gains reliefs originally enacted (in 1962, then 1965) for amalgamations and reconstructions are now the main reliefs relied upon in a form of transaction that in effect achieves the opposite purpose, namely a demerger.

Tax consequences of indirect demergers 22.15 Without any tax reliefs, indirect demergers would also be very expensive transactions in tax terms. However, the reliefs available for a scheme of reconstruction have been available for demergers for most tax purposes, as we have seen, even though this was only achieved by use of a concession by the Revenue. So, we will have a brief look at the different types of indirect demerger to demonstrate the workings of the reliefs. Again, these transactions will be discussed in more detail later in this Part In each case, it is taken as given that the transaction is part of a scheme of reconstruction. The simplest transaction is where a company transfers the shares of a subsidiary indirectly to a company that then issues shares to the shareholders of the transferor company in consideration as in Figure 22.2(a). Looking at the transferring company, first of all, we clearly have a disposal of a subsidiary for capital gains purposes. Since this is a scheme of reconstruction and there is no consideration given, the relief under TCGA 1992, s 139 is available to the transferor company. The disposal by the transferor company and the acquisition by the transferee company are both treated as being at a consideration that generates no gain and no loss; essentially, at a consideration equal to cost plus indexation. So there are no chargeable gain consequences to either company. Note also that where both TCGA 1992, s 139 and the substantial shareholding exemption might be applicable, the TCGA 1992, s 139 treatment is used and the substantial shareholding exemption is prevented from applying (by TCGA 1992, Sch 7AC, para 6). If the transaction is an income distribution, the company would have had to account for ACT (until it was abolished in 1998). For trading groups the relief for distributions in specie under the exempt distribution rules alleviated this concern for the company where the relief was available.

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Demergers: legal background 22.17 At shareholder level, a distribution in specie of the shares of a subsidiary, albeit directed to the transferee company, would be treated the same as any other distribution of profits; it would be chargeable to income tax under ITTOIA 2005, s 383. Again, the relief for this sort of demerger exempted these distributions from tax either as income or as capital distributions. Alternatively, the transaction could be a return of capital or a liquidation. Again, since we are merely assuming that the shareholders direct that the shares be transferred to the transferee company, we suggest that the consequences of either transaction would be the same as described above, for direct demergers. Whether or not the transaction is structured as a distribution for shareholders, the relief for schemes of reconstruction under TCGA 1992, s 136 is available effectively to treat the transaction as a reorganisation of share capital. As a result, the original base cost of the investment in shares of the transferor company is split between those shares and the shares now held in the subsidiary that was distributed. This is the same result as for direct demergers, albeit by a more direct route, as these transactions actually are schemes of reconstruction.

Conclusion 22.16 As can be seen, the indirect demerger route has always been the more tax efficient, with capital gains reliefs available for as long as there has been taxation of capital gains, in other words since 1962 (or before to the extent that reconstruction reliefs might have been relevant to the stamp duty charges). This situation was made even more tax friendly when the exempt distributions regime was introduced in 1980. Again, given the numerical issues raised at the beginning of this chapter, these are likely to remain the most common routes to a demerger.

STAMP TAXES AND INDIRECT DEMERGERS 22.17 In an indirect demerger, for stamp tax purposes there is consideration for the assets demerged, in the form of the shares issued by the receiving company. Therefore such a transaction will give rise to stamp tax costs unless a relief is available. Reconstruction reliefs as described in Chapter 2 may be available if the conditions are satisfied. In an indirect partition demerger, as in Figure 22.2(b), the ‘replication of shareholdings’ condition cannot be satisfied, so such a demerger cannot qualify for relief and any stamp duty charge will remain payable. In relation to stamp duty, such difficulty disappears if B is a non-UK company, as stamp duty does not normally have to be paid on transfer of non-UK company shares. 467

22.17 Demergers: legal background In the case of the demerger of a business rather than a subsidiary (as in Figure 22.4), SDLT, LTT, LBTT and/or stamp duty may arise if the assets of the business include UK land and/or shares. Again, if appropriate conditions are satisfied as set out in Chapter 2, such a demerger will qualify for reconstruction relief. If reconstruction relief is not available because the ‘replication of shareholdings’ condition is not satisfied (perhaps because the demerger is a mechanism to separate different businesses between different groups of shareholders), it is still possible that any transfer of UK land may qualify for acquisition relief, reducing the rate of tax to 0.5% in the case of SDLT and LTT or a proportion of the full charge, currently 12.5%, in the case of LBTT.

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Chapter 23

Liquidation distributions

INTRODUCTION AND COMMERCIAL PURPOSE 23.1 The essence of a liquidation demerger is that the distributing company enters a voluntary winding up and the businesses to be segregated are distributed separately. Figures 23.1(a) and 23.1(b) show demergers of a company with two trades and of one with two subsidiaries, respectively. Of course, the shareholder pool can also be segregated in liquidation demergers. Figure 23.1(a)

Figure 23.1(b)

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23.1 Liquidation distributions In this scenario, the exemption under CTA 2010, s 1075 for distributions in specie would not be relevant, as a distribution in a winding up is not a distribution for the purposes of the Corporation Tax Acts (CTA 2010, s 1030). Instead, the corporate gains would be exempt under TCGA 1992, s 139 and the shareholder gains under TCGA 1992, s 136, subject to appropriate clearances from HMRC. There are various reasons why companies use the liquidation route as opposed to the statutory routes in CTA 2010, s 1076, 1077 or 1078. The most likely reason for choosing this approach to a demerger is that the exempt distribution route is not available. For example, the relevant activities to be demerged might not both be trading activities, as required by the exempt distribution route. But there is no such limitation in the reconstruction reliefs, which only require the activities to be separated to be businesses, so a liquidation demerger circumvents this problem. Another common reason is that the company does not have sufficient distributable reserves to be able to make a distribution in specie of the business units concerned. Remember that a company can only make a distribution out of its distributable reserves (that is ‘its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made1) provided that the value of the assets to be distributed are at least equal to the book value of such assets.’ In the absence of sufficient reserves, the transaction would constitute an unlawful distribution and an unlawful reduction of capital. Although this is not a tax issue, in such a case, HMRC used to refuse clearance under CTA 2010, s 1091 simply because it is not within HMRC’s remit to give clearance for an unlawful transaction. (More recently, the authors’ experience is that HMRC does not always commit on the sufficiency of reserves.) However, the distribution of assets to shareholders of a company on its winding up is specifically excluded from the definition of distributions in CA 2006, s 829(2)(d). Therefore, an in specie distribution of assets in a liquidation is not restricted by reference to the level of available distributable reserves, so a liquidation is a useful demerger mechanism when there is a lack of distributable reserves. The reason for the demerger may itself be the stumbling block. If a company wanted to split up its business interests because it is intending to divest itself of non-core activities in due course, this would clearly contravene the condition in CTA 2010, s 1081(5)(d) that the demerger should not take place in order to facilitate the sale of a part of the business. But there is, again, no such restriction on a liquidation demerger.

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Liquidation distributions 23.4 Since the change to company law on the reduction of a company’s capital, in CA 2006, s 641, many demergers have been carried out using reductions of capital (see Chapter 25), rather than liquidations, so this mechanism has somewhat fallen out of favour in recent years.

1 CA 2006, s 830(2).

LEGAL BACKGROUND 23.2 The relevant company legislation here is Insolvency Act 1986 (‘IA 1986’), s 110, particularly IA 1986, s 110(1)–(3)(a). IA 1986, s 110 23.3 ‘(1) This section applies, in the case of a company proposed to be, or being, wound up voluntarily, where the whole or part of a company’s business or property is proposed to be transferred or sold to another company (‘the transferee company’), whether or not the latter is a company within the meaning of the Companies Act. (2) With the requisite sanction, the liquidator of the company being, or proposed to be, wound up (‘the transferor company’) may receive, in compensation or part compensation for the transfer or sale, shares, policies or other like interests in the transferee company for distribution among the members of the transferor company. (3) The sanction requisite under subsection (2) is – (a) in the case of a members’ voluntary winding up, that of a special resolution of a company, conferring either a general authority on the liquidator or an authority in respect of any particular arrangement …’ Analysis 23.4 A liquidation requires the liquidator to pay off all the company’s creditors, collect all its debts and then realise its assets and distribute the proceeds to the shareholders. IA 1986, s 110 allows a company in members’ voluntary liquidation effectively to distribute individual business units or subsidiaries to another company, in return for an issue of shares, rather than having to realise those assets and distribute the proceeds. In a liquidation, the

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23.5 Liquidation distributions normal Companies Act rules in respect of realised profits are not applicable, so the question of distributable reserves is not in point. The inevitable result, however, of a liquidation demerger is that the original company that owned the business units ceases to exist. This process requires a special resolution of the shareholders of the company resolving to implement the liquidation scheme. In addition, there are procedures allowing dissenting shareholders and creditors to object to the liquidation and to insist on being bought out (see 23.19). Accordingly, it is generally easier for private companies to use this route to split up their business than it is for public companies. The majority of the directors of the company must swear a statutory declaration of solvency stating that, having made a full inquiry into the company’s affairs, they are satisfied that the company will be able to pay its debts in full, together with any interest, within a specified period not exceeding 12 months from the commencement of the winding up. Furthermore, such a route is often considered unattractive to larger groups or public companies due to the perceived stigma attached to putting a company into liquidation. On the appointment of a liquidator, the powers of the directors cease unless the liquidators or the shareholders in general meeting allow them to continue in any way.

TAX ANALYSIS 23.5

Let us look at the tax analysis of Figures 23.1(a) and 23.1(b).

Is it a reconstruction? 23.6 The first analysis we must carry out is whether such a transaction is a reconstruction as defined by TCGA 1992, Sch 5AA. The availability of any other reliefs, specifically TCGA 1992, s 139 for the transferor company and TCGA 1992, s 136 for the shareholders, will flow from that analysis. Let us remind ourselves of the four conditions to be satisfied if the transaction is to be a reconstruction, per TCGA 1992, Sch 5AA: ●●

there must be an issue of ordinary share capital by at least one transferee company to shareholders of ordinary share capital (or particular classes of ordinary share capital involved in the reconstruction) of the transferor company; and

●●

that share issue by the transferee company must be pro rata to the shareholdings of the relevant classes of ordinary share in the transferor company; and 472

Liquidation distributions 23.8 ●●

the business carried on by the transferor company must subsequently be carried on by one or more successor companies; or

●●

there must be a scheme or arrangement under CA 2006, Part 26.

The first condition 23.7 Looking at IA 1986, s 110(1) and (2) (above), it is clear that the liquidator is entitled to transfer assets of a company in liquidation to a transferee company in return for shares of the transferee company. Strictly, however, it appears that the transferee companies must issue shares to the liquidator, not to the original shareholders of the company being wound up, which doesn’t satisfy the requirements of IA 1986, s 110(2). However, it is usual for the liquidator to direct that the shares of the transferee company are allotted and issued directly to the shareholders of the transferor company so that the liquidator never acquires legal title. Whatever the correct technical analysis, as a practical matter, the authors have never seen HMRC argue this point or otherwise suggest that the first condition is not satisfied in a liquidation demerger. So the New Cos can issues shares to the shareholders of Trade Co or Hold Co, and the first condition is clearly satisfied in both examples.

The second condition 23.8 There is nothing in IA 1986, s 110(2) to suggest that the shares must be issued pro rata by the transferee company. However, the nature of the duties of a liquidator include treating all shareholders equally and, of course, all the ordinary share capital of one particular class of the transferor company will carry the same rights. So it seems likely that it is a legal imperative, regardless of the precise wording of IA 1986, s 110, that the shares of the transferee company are issued pro rata to the shareholdings of the relevant class of ordinary shares in the transferor company. In any case, even if company law or insolvency law do not require a pro rata issue of shares by the transferee company, it follows from the definition in TCGA 1992, Sch 5AA that this is required for tax purposes. Therefore, the second condition is satisfied, the New Cos issue shares pro rata to the shareholders of Trade Co or Hold Co. In these examples matters are very straightforward. There is only one class of ordinary share capital in the transferor company and each transferee company can be assumed to issue shares to shareholders of the transferor company pro rata to their shareholdings. What happens, however, where the shareholders are to be segregated as shown in Figure 23.2?

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23.8 Liquidation distributions Figure 23.2

In this example, the business of the transferor company is being segregated into two successor companies, each of which will be owned by a different shareholder of the original company. In this case, there has to be a preliminary reorganisation of the share capital of the original company in order that the transferee companies can issue shares to the holders of each class of ordinary share capital pro rata to their current holdings of each class. We have assumed that the ordinary share capital of the original company will, therefore, be reorganised into A and B shares. Ideally, these shares would entitle the shareholders to shares in the successor companies that will be carrying on the A or B businesses respectively. But this cannot be done directly, as the Articles of one company cannot bind another. Instead, the A shares would have all the rights over the A business or subsidiary, and the B shares would have all the rights over the B business or subsidiary. Under the terms of the scheme of reconstruction, the rights of the A shareholder can then include the right to direct that the business or subsidiary be transferred to Business A, which will issue shares pro rata to the shareholdings in the original company. A preliminary reorganisation of this type is, of course, tax-free, being an ordinary reorganisation of share capital to which TCGA 1992, s 127 applies (Chapter 6). TCGA 1992, Sch 5AA, para 6 tells us that such preliminary reorganisations are also ignored in determining whether the transactions amount to a reconstruction (Chapter 16). So the second condition requires Business A to issue ordinary share capital pro rata to the A shareholders of the original company and Business B to issue ordinary share capital pro rata to the B shareholders of the original company. These conditions are easily satisfied, so even in a partition demerger, the second condition is satisfied. 474

Liquidation distributions 23.10

The third condition 23.9 Let us remind ourselves of the relevant part of the definition, TCGA 1992, Sch 5AA, para 4(1): ‘(1) The third condition is that the effect of the restructuring is – (a) where there is one original company, that the business or substantially the whole of the business carried on by the company is carried on – (i)

by a successor company that is not the original company; or

(ii) by two or more successor companies (which may include the original company);’ In (a) the original company’s business is separated and subsequently carried on by more than one successor company. Since the demerger is by liquidation of the transferor company, it is also clear that none of the successor companies will be the original company. (As we will see, in both other types of demerger, the original company will usually also be one of the successor companies.) But there are in each case two successor companies which, together, carry on the activities of the original company. Therefore, the third condition is satisfied.

The fourth condition 23.10 Since only one of the third or fourth conditions needs to be satisfied, we do not strictly need to look at the fourth condition. On that basis, we have to ask when we would need to consider the fourth condition, ie a court order under CA 2006, Part 26? We looked at CA 2006, Part 26 in detail in Chapter 17. One of the main reasons given in that chapter for using the CA 2006, Part 26 process is simply to get the court’s permission for carrying out a transaction with a lower threshold of shareholder approval required. In the context of a scheme of reconstruction for capital gains and corporation tax purposes, however, the only reason we would need to consider the CA 2006, Part 26 process is where we fail the third condition of TCGA 1992, Sch 5AA, the business continuity requirements. The authors have not yet come across a situation where a scheme of reconstruction fails that third condition, thus necessitating the use of the CA 2006, Part 26 process in order to satisfy the terms of TCGA 1992, Sch 5AA. Of course, there will be situations, particularly with widely held companies, where the CA 2006, Part 26 process is required, anyway, for wider company law reasons (including, for example, the lower threshold of shareholder approval required). But that will be for company law purposes only and is not relevant to the application of TCGA 1992, Sch 5AA. 475

23.11 Liquidation distributions

Conclusion 23.11 Overall, we have just demonstrated that a liquidation demerger is a reconstruction as defined by TCGA 1992, Sch 5AA. Readers will recall from Chapters 15 and 16 that matters were not so straightforward before the introduction of that definition when it was then necessary to rely on Statement of Practice 5/85 or the predecessor Press Release. We have also shown that demergers by dissolution without winding up, under CA 2006, Part 26, may be possible but are probably not commercially viable under current legislation.

Reliefs for the distributing company 23.12 Once we have ascertained that we have a scheme of reconstruction, we can look at the reliefs available for the demerger transactions. For the transferor company, relief from the charge to corporation tax on chargeable gains is given by TCGA 1992, s 139 whereby the transfer is deemed to be at such a consideration as to give no gain and no loss for capital gains purposes. This treatment applies to both the transferor company, which thereby has no chargeable gain, and to the transferee, which thereby has a base cost equal to the transferor’s base cost (including indexation if applicable). We have been through TCGA 1992, s 139 in detail already (Chapter 18), but here is a reminder of its requirements: ●●

there must be a scheme of reconstruction (TCGA 1992, s 139(1)(a));

●●

there must be a transfer of all or part of the company’s business to another company (TCGA 1992, s 139(1)(a));

●●

the companies must be UK tax resident or within the charge to UK corporation tax on chargeable gains (TCGA 1992, s 139(1)(b), (1A));

●●

the transferor company must not receive any consideration for the transfer (TCGA 1992, s 139(1)(c)).

We clearly satisfy the first of these requirements by virtue of being a TCGA 1992, Sch 5AA reconstruction. And by satisfying the third condition of TCGA 1992, Sch 5AA, the business transfer condition, we satisfy the second requirement. Let us assume that the third requirement is satisfied for the purposes of our examples and the fourth requirement is satisfied in a liquidation because, as a

476

Liquidation distributions 23.12 matter of law, the consideration, which is the issue of shares by the transferee company or companies, is to the liquidator, not to the transferor company. The liquidator then passes these shares to the shareholders of the transferor company. We have previously noted that TCGA 1992, s 139 itself does not require an issue of consideration shares by the transferee company. That is a requirement of the definition of a scheme of reconstruction in TCGA 1992, Sch 5AA. This requirement would have been inserted into that definition because transactions that previous jurisprudence had held to be schemes of reconstruction required the issue of consideration shares. Remember that TCGA 1992, Sch 5AA was intended to codify the then current position as to what was a scheme of reconstruction, not to change the law in any way. Overall, however, it is clear that both of the examples given above fulfil the requirements for the corporate relief given by TCGA 1992, s 139 to apply. The transfer of assets to the new companies will be on a ‘no gain no loss’ basis. Accordingly, the company in liquidation will not be chargeable to corporation tax on a chargeable gain and the assets will be treated as having been acquired by the new companies at the original cost and, for the purposes of indexation, at the date they were originally acquired. As a matter of insolvency law, it seems that the distribution in specie of the business units in a liquidation could be carried out directly to the shareholders of the company, under IA 1986, s 110(1). However, even if this were a possible transaction, it would not usually satisfy the requirement of TCGA 1992, s 139 that the business be transferred to another company. Even if the shareholders were to be companies themselves, the transaction must still qualify as a reconstruction, as defined in TCGA 1992, Sch 5AA, in order for the TCGA 1992, s 139 relief to be available and if the assets were transferred in liquidation to a corporate shareholder, there would be no issue of consideration shares, so the definition of a scheme of reconstruction would not be satisfied. That is why a reconstruction under IA 1986, s 110 generally involves the voluntary winding up of a company and the distribution, in the course of the liquidation, of the business units to new companies set up by the shareholders of the existing company. As a matter of completeness, where the distributing company is distributing shares in subsidiaries, we would normally consider whether the substantial shareholding exemption, TCGA 1992, Sch 7AC, might apply to the transfer. However, the effect of TCGA 1992, s 139 is a disposal at no gain and no loss to the distributing company, and TCGA 1992, Sch 7AC, para 6(1)(a) tells us that the substantial shareholding exemption cannot apply to such disposals. So the exemption is not in point so far as the distributing company is concerned.

477

23.13 Liquidation distributions

Reliefs for non-corporate shareholders 23.13 A distribution in the course of a liquidation is always a capital distribution, following TCGA 1992, s 122(5) (subject to the comments in Chapter 19). It cannot be an income distribution by virtue of CTA 2010, s 1030. Therefore, the distribution of shares in the new companies will not give rise to an income tax charge for the shareholders of the new companies. We need to see, therefore, whether the reliefs from capital gains for shareholders, given by TCGA 1992, s 136, can apply. There are three primary conditions for TCGA 1992, s 136 to apply (we are assuming for all purposes that the demerger is being carried out for bona fide commercial reasons and not for the avoidance of tax): ●●

there must be an arrangement between a company and its shareholders (TCGA 1992, s 136(1)(a));

●●

this must be for the purposes of a scheme of reconstruction (TCGA 1992, s 136(1)(a));

●●

another company must issue shares to the shareholders of the first company, pro rata to their shareholdings in that company, whether those original shares are retained or cancelled (TCGA 1992, s 136(1)(b)).

It is hard to see how a members’ voluntary liquidation can be anything other than an arrangement between a company and its shareholders, and the nature of the liquidation demerger is that this will be in connection with the scheme of reconstruction. The final condition is met by virtue of satisfying the pro rata share issue requirement of the second condition of TCGA 1992, Sch 5AA, which is actually more onerous than the TCGA 1992, s 136 requirement (ie TCGA 1992, Sch 5AA requires the share issue to be precisely pro rata, whereas TCGA 1992, s 136 refers to ‘as nearly as may be in proportion to …’). Overall, however, the requirements of TCGA 1992, s 136 are clearly satisfied for our examples and the TCGA 1992, s 136 relief is available. As a result, the shareholders of the original company are treated as not having disposed of their shares. Instead, a reorganisation of the share capital is deemed to have occurred and the shareholders’ base costs of those shares are now split between the shareholdings in each of the two successor companies. The base costs for any future disposals are allocated according to TCGA 1992, ss 129 and 130 (Chapter 6).

Reliefs for corporate shareholders 23.14 We must also look at the position for corporate shareholders that hold more than 10 per cent of the share capital, to whom the substantial shareholding exemption might apply. 478

Liquidation distributions 23.14 If all the conditions relevant to the substantial shareholding exemption are satisfied, then the substantial shareholding exemption might prima facie apply in such a hypothetical scenario. Let us assume that the shareholder company is a qualifying company, perhaps a holding company of a trading group, and that it holds at least 10 per cent of the ordinary share capital of the distributing company (in Figure 23.3, S holds 25 per cent). Figure 23.3

Since 1 April 2017 the substantial shareholding exemption only requires that the shares being disposed of are a trading company or holding company of a trading group or sub-group. So, if company A in Figure 23.3 is a trading company, it appears that the substantial shareholding exemption could apply to the shareholder company, S, in terms of the deemed part-disposal of its shares in A. So, which takes priority, the substantial shareholding exemption or the reorganisation provisions as applied by TCGA 1992, s 136? We start with TCGA 1992, Sch 7AC, para 4(1)(b) and (5), which tells us to ignore the no disposal fiction imposed by the application of TCGA 1992, s 127. This is obviously necessary as, otherwise, there is no disposal for tax purposes to which the substantial shareholding exemption might apply. Then TCGA 1992, Sch 7AC, para 4(3)(a) tells us that the substantial shareholding exemption applies in priority to the reorganisation provisions. Thus, in Figure 23.3 the corporate shareholder would be treated as having disposed of the shares in A, with the gain being exempt. As discussed in Chapter 11, this effectively ‘banks’ the substantial shareholding exemption for the corporate shareholder. The other, non-corporate, shareholder(s) will still be entitled to the reorganisation treatment by virtue of TCGA 1992, s 136. Of course, if the group being demerged is not a trading group, then the reorganisation provisions will apply to the corporate shareholder as it does to any non-corporate shareholders. 479

23.15 Liquidation distributions

Further tax issues on liquidation demergers TCGA 1992, s 179 charges 23.15 A charge under TCGA 1992, s 179 may arise as a result of a reconstruction by liquidation, if an asset has previously been transferred between companies in the group, but those companies end up in separate sub-groups as a result of the demerger (for example, see Figure 23.4). Assume that C had been transferred to B from A some time ago. On demerger, C leaves HoldCo group and a TCGA 1992, s 179 charge arises. Figure 23.4

However, as we have now seen (in 18.23), HMRC’s view of the rules introduced by FA 2011 is that the degrouping charge in such cases disappears (although the authors are not convinced that HMRC’s position here is technically robust). If it is necessary to prevent such a degrouping charge arising, the usual method is to transfer all such assets up to the principal company (ie the company being liquidated) and to distribute each such asset separately in the liquidation. By this route, each asset is transferred under the protection of TCGA 1992, s 139 to the New Co (Figure 23.5). That said, the assets transferred might, as a result, be subject to other charges, such as SDLT on chargeable interests in land or capital allowances balancing adjustments. Figure 23.5

480

Liquidation distributions 23.18

Capital allowance balancing charges 23.16 We have seen cases where the demerger of a trade, rather than of a trading company, by way of distribution in a liquidation would generate capital allowance balancing charges. This is because the distributing company would be treated as if it has ceased to trade when the trade is transferred and the assets on which capital allowances have been claimed are deemed to be disposed of at market value. Where this exceeds the tax written down value, a balancing charge arises and reduces the tax efficiency of the demerger. There is no obvious resolution to this issue in liquidation demergers and it may be necessary to proceed by a different route such as demerger by return of capital.

Group hold-over relief unwinds 23.17 Rollover for business assets can be claimed in a group scenario, by TCGA 1992, s 175, so that if one company in a group has disposed of a business asset at a gain, the gain can be rolled over (or held over) into acquisitions of business assets by other group companies. The issue arises where there is a held-over gain in the company that made the original disposal, by TCGA 1992, ss 154 and 175(3), because of the fiction imposed by TCGA 1992, s 176 that the group as a whole is carrying on one composite trade. The held-over gain comes into charge when the new asset is no longer used for the purposes of the claimant’s trade. In group hold-over cases, the HMRC view is that if the claimant company leaves the group, as it does when distributed out in a demerger, the claimant company is no longer carrying on that composite trade. Therefore, the new asset will no longer be in use in a trade carried on by the claimant and the gain that was held over comes back into charge. This interpretation is not held universally, but to carry out a demerger with a material exposure if HMRC were to be correct in its analysis would be irresponsible to say the least. Again, there is no obvious resolution to this issue in liquidation demergers. The answer in the past has been to arrange for a form of demerger where the claimant company does not leave a group, which necessarily means a form of demerger other than a liquidation.

COMMERCIAL ISSUES ON LIQUIDATION DEMERGERS Insertion of a new holding company 23.18 From a commercial point of view, it may not be practical to liquidate the top company in a group in order to split the group into two or more groups. For example, the company may have a large number of contracts which cannot 481

23.18 Liquidation distributions easily be assigned to another company or it may hold long-term leases which can only be assigned with the consent of a landlord. Banking covenants can also be a sticking point. The legal costs involved could be considerable and the other parties to the contracts might take the opportunity to renegotiate the terms of the agreements more favourably to themselves. In addition, the liquidation should be weighed up against the potential tax advantages before proceeding. Another reason is that a long-standing holding company will have a lengthy commercial history. A liquidator will be reluctant to distribute the assets without being certain that liabilities will not appear in the company. This is not likely to be a problem for a new, clean company with no history. More generally, the adverse public perception surrounding a liquidation, whatever the circumstances leading to it, can damage the commercial standing of a company in the business community and this needs to be factored into the equation. There is no point in effective tax planning if the net result is that the business suffers. These potential difficulties can often be addressed by inserting a new holding company above the original company. The group can then be reorganised so that the business units to be demerged are placed directly under the new holding company, which can then be placed into members’ voluntary liquidation (see Figure 23.6). Figure 23.6

There are three ways of inserting the new holding company: ●●

by a share-for-share exchange using the exemption under TCGA 1992, s 135 (Chapter 8) for a reorganisation, which requires the consent of 100 per cent of the shareholders of the company as shareholders cannot be forced to sell their shares against their will;

●●

by a takeover offer in accordance with CA 2006, s 974. Once acceptances have reached 90 per cent in value of the shares to which the offer relates, the minority shares can be compulsorily acquired using the provisions of CA 2006, s 979; or 482

Liquidation distributions 23.21 ●●

by cancellation and reissue of the share capital of the original parent company (Chapter 17), taking advantage of the relief at TCGA 1992, s 136 for reconstructions.

Dissenting shareholders 23.19 An IA 1986, s 110 liquidation requires specific agreements to allow the liquidator to proceed with the distribution of assets. In the case of a members’ voluntary winding up, a special resolution (unless an extraordinary resolution is required) requiring a 75 per cent majority of the shareholders to be in favour needs to be passed to confer the necessary authority on the liquidator. However, as mentioned above, if a shareholder objects to the resolution, they can, under IA 1986, s 111, ‘… require the liquidator either to abstain from carrying the resolution into effect or to purchase his/her interest at a price to be determined by agreement or arbitration’. Effectively, therefore, a dissenting shareholder can prevent the liquidation from being carried out. More usually, the shareholder must be bought out before the transaction can proceed. The transaction is therefore typically structured so that the shareholders’ meeting to sanction the scheme takes place some days before the liquidation itself, enabling the liquidation to be aborted if the objections were significant.

Liquidator indemnities 23.20 The liquidator will usually require binding indemnities from the directors of the company to be liquidated. This is because the liquidator becomes personally responsible for the disposition of a company’s assets during the course of the liquidation. If, following a liquidation and striking off of a company, there is a claim against that company, the liquidator would be required personally to make restitution to the claimant. The indemnity would provide that the claim should be settled instead by the company that has inherited the appropriate part of the business activities that have now been separated. As noted above, this is a major reason for using a new Top Co structured as in Figure 23.6.

CONCLUSION 23.21 There are probably many further reasons that might suggest that this form of demerger is not appropriate in any situation. It is not possible (and it is not our intention) to give an exhaustive list of the potential issues.

483

23.22 Liquidation distributions It is, however, important to bear in mind that the issues are often nothing to do with tax; they might be regulatory, commercial or something else. In at least one recent case, for example, liquidation was not appropriate because the company concerned was a very old family company and the members had an emotional attachment to it, so they were not prepared to see it struck off, even though that might have been the most cost-effective way of achieving their demerger. The overriding conclusion, of course, is that it is vital to know and understand your client, both in terms of tax issues and history and in the wider context. Either way, liquidation demergers have historically been one of the most common mechanisms for business separations.

LIQUIDATION DEMERGERS AND STAMP TAXES 23.22 The fact that a demerger proceeds by liquidation has little bearing on the stamp tax consequences of the transfer of either shares of subsidiaries or assets of businesses to new companies. The transactions in Figures 23.1(b) and 23.3 are capable of qualifying for relief from stamp duty under FA 1986, s 77 if appropriate conditions are met as set out in Chapter 2. In particular, it is now necessary to consider the anti-avoidance restriction in the relief, set out in FA 1986, s 77A, although HMRC has confirmed to one of the authors that the simple act of appointing a liquidator does not constitute a change of control for these purposes. Equally, the transaction in Figure 23.1(a) will qualify for reconstruction relief from stamp duty and SDLT if the conditions are met. Transactions such as that set out in Figure 23.5 involve a degree of reorganisation within the group before the liquidation. This will normally be an issue if a new holding company is inserted at the top of the group as described in 23.18. Transfers in the course of such a reorganisation may qualify for group relief from stamp taxes, even though there is an intention then to break up the group. In the case of intra-group share transfers, these should be carried out before there is a commitment to the liquidation – certainly before the shareholder meeting at which the liquidation resolution is passed. In the case of intra-group transfers of UK land, breaking the group may lead to withdrawal of group relief previously claimed. However such relief will not be clawed back if the subsequent demerger qualifies for reconstruction relief. If it is necessary to insert a new holding company (New Co) at the top of the group prior to the demerger as in Figure 23.6, it is normally possible to ensure that this qualifies for relief from stamp duty under FA 1986, s 77 as set out in Chapter 2, provided this is not part of an arrangement to transfer ultimate ownership to one or more identified third parties (FA 1986, s 77A).

484

Liquidation distributions 23.25

VALUE ADDED TAX 23.23 It will be most unusual for a liquidation distribution exercise to itself give rise to any output VAT. The question, as always, is whether a refund can be obtained of the input VAT on incidental professional and other costs, including the liquidator’s fee.

Superimposition of new Top Co 23.24 Sometimes the first step in the exercise will be the superimposition of a new holding company, see above. This will be a share-for-share exchange, and the VAT position will be as explained in 8.23–8.30.

Position of the ultimate shareholders 23.25 Turning to the distribution exercise itself, the first question, as usual, is whether the ultimate shareholder receiving the shares in a New Co or the New Cos carrying on a business in relation to his shares in the distributing company and will be in relation to the New Co or New Cos: see 3.6 above. Often he will not be, particularly if he is an individual. If he is not carrying on a business, it may well be the case that he does not in fact incur any expenses in relation to the transaction; but if he does, any input VAT will be irrecoverable. Suppose he is carrying on a relevant business (for example, the rendering of management services to the company or companies). The liquidation exercise does not in our view involve any disposal or supply by him: he is merely receiving a particular kind of distribution, namely the shares in New Co or New Cos, indirectly from the distributing company. In principle the receipt of a distribution by a shareholder does not involve a supply by him, any more than the receipt of a dividend does. Therefore, any input VAT which he incurs should be attributable to the relevant business of his. For example, if that is the rendering of taxable management services, his input VAT should be wholly recoverable. But if, say, his sole relevant business activity is the systematic making of loans at interest (see 3.6), his supplies will be exempt and his input VAT wholly irrecoverable. Where he performs a mixture of taxable and exempt supplies in relation to the companies, his input VAT will be residual: where his exempt supplies are financial (for example, lending to the relevant company or companies at interest), the input VAT must be apportioned ad hoc, see 8.24.

485

23.26 Liquidation distributions

Position of the distributing company 23.26 The distributing company may transfer actual businesses to the New Cos. If so, each transfer will normally be the transfer of a part of a business as a going concern (TOGC) by the distributing company. Therefore, the exercise will not constitute supplies of goods or services by the distributing company. The TOGC rules are in VAT (Special Provisions) Order 1995 (SI 1995/1268), art 5(1)–(3) and are explained in 3.12–3.14. If the transfer is a TOGC, it does not count as a supply of goods or services by the distributing company. Any incidental input VAT which it incurs in connection with the exercise will count as wholly attributable to the activities of the business being transferred, so that if, for example, it is a wholly taxable business, the VAT will be wholly recoverable: Abbey National plc v Customs & Excise Commissioners [2001] STC 297, ECJ. Where the distributing company is transferring shares in subsidiaries that may be a TOGC: see 3.14. The question arises as to whether the distributing company is making a supply of shares at all, because a transaction for no consideration is not a supply for VAT purposes. In our view it is not making a supply. What it is essentially doing is making a special type of distribution to its shareholders; and the making of a distribution of shares to shareholders is not, on general principles, a transaction for consideration. It is true that the conventional drafting of the documents is that the distributing company transfers assets to New Co in consideration of New Co’s issuing shares to the ultimate shareholders, but IA 1986, s 110 does not use the word ‘consideration’ (it uses the word ‘compensation’), and in any event for VAT ‘consideration’ has an EU meaning which is not the same as the English contract and company law meaning. If this is correct, the distributing company makes no supply for VAT (and has nothing to add to Box 6 of its return) and any input VAT incurred by it will again be regarded as incurred by it for the business it has in relation to the subsidiaries. For example, where that is the rendering of taxable management services to them its input VAT should be wholly recoverable. Where the distributing company is VAT-grouped with the subsidiary, in practice any input VAT should be treated as attributable to the subsidiary’s business. Where the distributing company has just transferred a business down into a subsidiary before demerging the subsidiary, that transfer would normally be a TOGC and the transfer of the shares in the subsidiary would be a non-supply, see above. We consider that any input VAT incurred by the distributing company is wholly attributable to the business transferred into the subsidiary.

486

Liquidation distributions 23.27

Position of the New Cos 23.27 The New Cos will rarely incur any input VAT on professional fees or other incidental expenses of the demerger exercise: expenses of this sort will generally be incurred by the distributing company or the ultimate shareholders, except in the unusual case where New Co is an existing company with an existing business. In brief, however, the New Cos will make no supply when they issue shares to the ultimate shareholders: this follows from the general principle that the issue of shares or securities by a company is not a supply by it, see 8.26 above. The receipt by a New Co of the business or the shares which are transferred to it is, of course, an acquisition, not a supply, by it, whether or not the transfer to it is a TOGC. Assuming that the New Co will be carrying on a relevant business in relation to the assets which it acquires, the recoverability of any input VAT which it incurs on incidental costs will be governed by the nature of the business that the New Co will be carrying on. For example if the New Co acquires a ‘real’ business which makes wholly taxable supplies, the input VAT will be wholly recoverable. If it acquires shares in companies to which it will be rendering taxable management services, again its input VAT should be wholly recoverable. A New Co which will be carrying on a taxable business should register for VAT as soon as possible.

487

Chapter 24

Exempt distributions

HISTORICAL INTRODUCTION AND COMMERCIAL PURPOSE 24.1 The Chancellor of the Exchequer unveiled a new code of tax relief in his Budget speech on 26 March 1980. His stated intention was that the legislation would allow a trading company or group to split the ownership of its activities by way of a distribution in specie. He described this type of transaction as a ‘demerger’, a word that has now entered the vernacular. The legislation was not, however, included in the original Finance (No 2) Bill 1980, apparently due to its complexity (according to the Press Release of 26 March 1980), but was published later as a separate Schedule. The code is contained in what is now CTA 2010, Part 23, Chapter 5 (ss 1073–1099) and TCGA 1992, s 192 and was designed to operate in addition to the capital gains legislation relating to reorganisations and reconstructions. It was widely reported in 1980 that the introduction of this beneficial new code was designed, at least in part, to allow a specific large trading group, which could not benefit from the existing reconstruction rules and Inland Revenue practice, to split up its business activities, ie to demerge. This may be so, but this legislation is not restricted to large groups and many small groups and companies have used the demergers legislation to achieve their commercial objectives. Indeed, by far the majority of demerger clearance applications received by HMRC under CTA 2010, s 1091 are for small private companies wishing to break up for a variety of reasons. This chapter explores the statutory demergers code and looks at the detail of the rules contained in CTA 2010, Part 23, Chapter 5 and TCGA 1992, s 192. We also look at how the code exists with other parts of the reorganisation and reconstruction reliefs, but first we must look at the legal context. The provisions for EU cross-border demergers are covered in Chapter 26. However, it is worth noting that the transactions described in CTA 2010, ss 1076, 1077 and 1078 are not akin to ‘divisions’, as described by the

488

Exempt distributions 24.4 Sixth Directive1 and the Mergers Directive2. They are, however, ‘partial divisions’, as described by the Mergers Directive. Ironically, since most major UK public company demergers in the last 20 years have used the exempt distribution route, or the return of capital route (Chapter 25), which is also a form of ‘partial division’, none of those demergers have been subject to the stakeholder protection rules of the Sixth Directive.

1 Sixth Council Directive 82/891/EEC of 17 December 1982 concerning divisions of public limited liability companies. 2 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005).

LEGAL BACKGROUND Companies Act provisions 24.2 All company distributions (whether of profits or assets) are governed by the provisions in CA 2006, Part 26 (Distributions of Profits and Assets). We do not propose to deal in depth with the subject of lawful or unlawful distributions in this text, but there are two provisions that concern us for the purposes of the legal basis for a demerger by way of a distribution in specie. CA 2006, s 830(2) 24.3 ‘A company’s profits available for distribution are its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.’ CA 2006, s 846 24.4 ‘(1) This section applies where – (a) a company makes a distribution consisting of or including, or treated as arising in consequence of, the sale, transfer or other disposition by the company of a non-cash asset, and (b) any part of the amount at which that asset is stated in the relevant accounts represents an unrealised profit. 489

24.5 Exempt distributions (2) That profit is treated as a realised profit – (a) for the purpose of determining the lawfulness of the distribution in accordance with this Part (whether before or after the distribution takes place);’ Analysis 24.5 This gives us two main principles of distributions in specie. First, that the distributing company has to have accumulated, realised profits, which are distributable reserves. Therefore, a distribution demerger is not lawful if the distributing company does not have any reserves. Secondly, those accumulated, realised profits must at least equal the book value of the assets to be distributed. This provision is often found to be helpful, rather than onerous, as the effect of CA 2006, s 846 is to treat the act of distribution as if it were also an act of realisation, so it is lawful to distribute non-cash assets in specie at book value. The carrying value of a trade or a subsidiary to be demerged is often very low in comparison to its market value simply because historic cost is low, so the level of distributable reserves required to be able lawfully to demerge a business by this method is often low compared to the market value. From a corporate law perspective, the reasoning behind the provisions of CA 2006, s 846 are that it is always open to the distributing company to sell the asset, whether it be a subsidiary or some other asset, to a third party at market value and thereby realise the profit on such asset. Once realised, the company could distribute the profit to its shareholders. If the company could undertake the transaction (getting rid of the asset and making a distribution to its shareholders) in two steps, there should be nothing to prevent it doing the same transaction in one step, by cutting out the sale and realisation of the profits.

OVERVIEW OF THE CODE 24.6 From a taxation perspective, the code contains specific exemptions from the distributions legislation for both the company and the shareholders. To put this into context, it is important to remember the tax consequences of company distributions in 1980: ●●

first, there was the income tax charge on the shareholders, together with the appropriate tax credit. This charge is still in point, under ITTOIA 2005, s 383 for individuals and without the exemption afforded by CTA 2010, s 1075 this would be a major discouragement to demergers, at least from the perspective of the shareholders;

490

Exempt distributions 24.7 ●●

then there was the charge to ACT for the paying company, the ACT being, in effect, the fiscal quid pro quo for the tax credit imputed to the shareholders. The ACT charge was levied at the lower rate of corporation tax on the whole distribution, so was probably a greater barrier to demergers than the income tax charge on shareholders, which for public companies would often be a relatively small amount per person, or exempt for many institutional shareholders.

Already, we can see that the distributions legislation was a major barrier to demergers at both shareholder and corporate levels. When we add in the commercial complexities of valuing the demerged business to arrive at the taxable distribution and other tax aspects – such as TCGA 1992, s 179 in respect of preliminary reorganisations – demerger via distribution in specie was just not a viable option. Nowadays, of course, there is no ACT charge to worry about, but the problem of shareholder income tax charges still remains, so the exempt demerger legislation is still widely used, nearly 40 years after its inception.

STRUCTURE OF THE CODE 24.7 The approach is to take demergers by distribution in specie outside the scope of the distributions legislation. The basic exemption and a series of detailed conditions are all contained in CTA 2010, ss 1075–1085. Because, however, this creates what was considered to be a ‘hole’ in that legislation, CTA 2010, ss 1086–1090 contain an anti-avoidance provision whereby certain payments, referred to as ‘chargeable payments’, made within five years of this type of demerger will be chargeable to income tax or to corporation tax on income. CTA 2010, s 1091 allows the Board of HMRC to give a pre-transaction clearance that the demerger will comply with the provisions of CTA 2010, Part 23, Chapter 5, as well as a further clearance that later payments will not be chargeable payments. CTA 2010, ss 1095 and 1096 contain provisions relating to returns to be made by a company of any demerger transactions carried out or of any potential chargeable payments made, and CTA 2010, s 1097 contains HMRC’s powers to call for information about the transactions. CTA 2010, s 1098 contains a number of relevant definitions. There are further provisions within TCGA 1992, s 192 to prevent unintended capital gains consequences, such as a TCGA 1992, s 179 charge when a 491

24.8 Exempt distributions demerged entity leaves a group. The original legislation also had a specific exemption from stamp duty on a demerger. Although this does not appear to have survived to the present, it is still usually possible to ensure that no stamp duty charge arises on an exempt distribution. CTA 2010, s 1073 – key terms, etc 24.8 ‘(1) The following are key terms in this Chapter– (a) “chargeable payment” (see sections 1088 and 1089), (b) “company concerned in an exempt distribution” (see section 1090), (c)

“the distributing company” (see section 1079),

(d) “exempt distribution” (defined in section 1075), and (e)

“relevant company” (defined in section 1080).

(2) For a further rule about chargeable payments made within 5 years after an exempt distribution see section 1028 (rule that they are not treated as repayments of capital for certain purposes).’ Analysis 24.9 CTA 2010, s 1073 explains the layout of CTA 2010, Part 23, Chapter 5. This is very much the pattern of the rewritten legislation of recent years, that an opening provision provides a ‘map’ to the legislation that follows.

CTA 2010, s 1074 – purpose of provision about demergers 24.10 ‘(1) The purpose of the provisions about demergers is to facilitate certain transactions by which trading activities carried on by a single company or group are divided so as to be carried on– (a) by two or more companies not belonging to the same group, or (b) by two or more independent groups. (2) In subsection (1) “the provisions about demergers” means– (a) this Chapter, except section 1078 (and section 1075, so far as relating to section 1078), and (b) section 1028 (chargeable payments not treated as repayments of share capital).’ 492

Exempt distributions 24.11 Analysis 24.11 The type of transaction referred to clearly mirrors some of the elements of distributions discussed earlier in this Part: the separation of business (in this case, trading) activities per se and that the post-separation entities are all to be companies or groups of companies. This appears to be purely an introductory paragraph and some might argue that it has no obvious legislative significance. Our view is rather different, as it seems to us that this is a piece of legislation that was inserted specifically to state the broad intention of Parliament. While it is clearly necessary to comply with the detailed conditions of the chapter, and most of these are prescriptive in nature, this introductory provision gives a clear framework for the interpretation of the legislation relating to demergers by exempt distribution. If a demerger does not, as required by CTA 2010, s 1074, give rise to a situation ‘whereby trading activities carried on by a single company or group are divided so as to be carried on by two or more companies not belonging to the same group or by two or more independent groups’, then it cannot be a transaction to which CTA 2010, s 1075 applies. This apparent restriction on the use of CTA 2010, Part 23, Chapter 5 may, conversely, be illusory simply because any kind of transaction that might otherwise comprise a distribution in specie to which this legislation is not intended to refer is also disallowed by the detailed conditions, as we shall see. Perhaps the most important restriction in these provisions – and certainly, in our experience, the most likely reason for the exemption to be denied – is that they are designed only for the separation of trading activities. So they are of no use or application to investment groups or companies or even for separating trading and investment activities. In these situations, other demerger strategies will have to be adopted. There is no obvious current reason for the distinction here between trading activities and non-trading activities, although readers will be aware of a long-standing prejudice against non-trading activities throughout the tax legislation (for example, business asset disposal relief (formerly known as ‘entrepreneurs’ relief’) and business property relief only apply to trading activities, etc)1. More recently, some commentators have been questioning the continued need for the trading requirement or, indeed, any of the complex conditions, in this legislation. CTA 2010, s 1099 defines a group for the purposes of this chapter as comprising a company together with all of its 75 per cent subsidiaries. The shareholding is to be measured disregarding any shares held directly or indirectly as trading stock (CTA 2010, s 1099(3)).

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24.12 Exempt distributions This definition does not apply to CTA 2010, s 1081(5)(d), however, where a group comprises a company and its 51 per cent subsidiaries.

1 This prejudice is a throwback to the very early days of income tax, when a distinction was drawn between the actual and notional income arising to the major landowners, who were the original taxpayers (under Schedule A in its original form), and profits arising from trade, which became much more important with the rise of the middle classes during the nineteenth century. In essence, the view that eventually became policy was that income from land arose without any effort from the landowner, whereas profits of a trade arose through the strenuous efforts of the traders and those profits should therefore be taxed more favourably due to the effort required to generate them. For more on this (and many other) points arising from the history of UK income tax, we suggest you try and track down a copy of Basil Sabine’s excellent History of Income Tax, now sadly out of print. For a more recent account see two works by Martin Daunton, Trusting Leviathan: The Politics of Taxation in Britain 1799–1914 (Cambridge University Press, 2001) and Just Taxes: The Politics of Taxation in Britain 1914–1979 (Cambridge University Press, 2002).

CTA 2010, s 1075 – exempt distributions 24.12 ‘(1) An exempt distribution is not a distribution of a company for the purposes of the Corporation Tax Acts. (2) In this Chapter “exempt distribution” means a distribution which is an exempt distribution by virtue of section 1076, 1077 or 1078.’ Analysis 24.13 This subsection introduces the term ‘exempt distribution’. Perhaps the most important point to note here is that although the transactions are referred to as exempt distributions, implying that they are distributions, but are not eligible to corporation tax, in fact, the subsection states that these transactions are not distributions at all for the purposes of the Corporation Tax Acts. (The Corporation Tax Acts are defined in Interpretation Act 1978, Sch 1 as ‘the enactments relating to the taxation of the income and chargeable gains of companies and of company distributions (including provisions relating to income tax)’.) This raises an interesting point of interpretation, although there is no practical significance to it. TCGA 1992, s 192(2)(a) (see 24.86) tells us that an exempt distribution is also not a capital distribution for the purposes of TCGA 1992, s 122. But capital distributions are defined (at TCGA 1992, s 122(5)) as ‘any distribution in money or money’s worth that is not income in the hands of the recipient’. If an exempt distribution is not a distribution for any purposes of the Corporation Tax Acts, and TCGA 1992 is clearly within the definition of

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Exempt distributions 24.15 the Corporation Tax Acts, then an exempt distribution cannot be a distribution for the purposes of TCGA 1992, s 122, and TCGA 1992, s 192(2)(a) is otiose. However, for the purposes of this book we will stick with the more traditional approach, that an exempt distribution is not an income distribution, for the purposes of the taxation of income. This subsection also informs us that the only transactions that are exempt distributions are those described within CTA 2010, ss 1076, 1077 and 1078. CTA 2010, s 1076 – transfer of shares in subsidiaries to members 24.14 ‘A distribution is an exempt distribution if– (a) it consists of the transfer by a company to all or any of its members of shares in one or more companies which are its 75% subsidiaries, (b) each of conditions A to F in sections 1081 and 1082 is met in respect of the distribution, and (c)

if the company making the transfer is a 75% subsidiary of another company, conditions L and M in section 1085 are met in respect of the distribution.’

Analysis – ‘Direct demergers’ 24.15 This section covers the first of the three specific types of exempt distribution. It refers to a transfer by a company of shares in one or more of its 75 per cent subsidiaries (see Figure 24.1), so long as the various statutory conditions referred to are satisfied. This is commonly known as a ‘direct demerger’ and clearly is a distribution or dividend in specie. Before 2002 this was a relatively uncommon form of demerger, simply because a distribution of assets (other than cash) by a company to its shareholders is not covered by any exemption from taxation of chargeable gains (see Chapter 22 for more detail). Therefore, the transfer of shares in a 75 per cent subsidiary to its shareholders would have been treated as a disposal by the company. This disposal would have been deemed to be at market value, as the distribution was not a bargain made at arm’s length and TCGA 1992, s 17 would have applied. This meant that a direct distribution was usually uneconomic for companies despite the exemption from the ACT charge, when applicable, and the shareholder-level exemption.

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24.15 Exempt distributions Figure 24.1 Direct demergers – CTA 2010, s 1076

It is difficult to understand the policy intention behind what was clearly a lacuna in the rules. For one thing, an indirect demerger is clearly exempt from all capital gains consequences with the availability of the TCGA 1992, s 139 exemption and the removal of the TCGA 1992, s 179 charge by virtue of TCGA 1992, s 192 (see later). Furthermore, the difficulty can easily be circumvented by structuring the demerger by way of a hive-down of the trade

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Exempt distributions 24.16 into a new subsidiary, followed by an indirect demerger of that subsidiary. Nevertheless, until 2002, the direct demerger route was distinctly less favourable in most cases than the indirect demerger. Following the introduction of the substantial shareholding exemption (TCGA 1992, Sch 7AC), the situation changed somewhat for trading subsidiaries of trading groups. Assuming all the appropriate conditions for the substantial shareholding exemption are satisfied, the exemption should apply to the deemed disposal of the subsidiary to the shareholders, as a result of which the chargeable gain would be exempt from taxation. Given the simplicity of the direct route, we have seen a number of direct demergers under this provision, particularly amongst small, privately owned groups with relatively small numbers of shareholders. But there are still mechanical difficulties with this form of demerger, as noted in Chapter 22. CTA 2010, s 1099 notes that ‘shares’ is to include ‘stock’, although this is to be read in the context of the legislation as being another word for shares. It does not extend the relief to loan stock, for example. CTA 2010, s 1077 – transfer by distributing company and issue of shares by transferee company 24.16 ‘(1) This section applies to a distribution which consists of both of the following– (a) the transfer by a company to one or more other companies (“the transferee company or companies”) of– (i)

a trade or trades, or

(ii) shares in one or more companies which are 75% subsidiaries of the company making the transfer, and (b) the issue of shares by the transferee company or companies to all or any of the members of the company making the transfer. (2) A distribution to which this section applies is an exempt distribution if– (a) each of conditions A to D in section 1081 and each of conditions G to K in section 1083 is met in respect of the distribution, and (b) if the company making the transfer is a 75% subsidiary of another company, conditions L and M in section 1085 are met in respect of the distribution.’

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24.17 Exempt distributions Analysis – ‘Indirect demergers’ 24.17 CTA 2010, s 1077(1)(a)(i) refers to the transfer by a company of a trade or trades to one or more transferee companies and the issue of shares by the transferee companies to any or all of the members of the distributing company (see Figure 24.2). Figure 24.2 Indirect demergers – CTA 2010, s 1077(1)(a)(i)

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Exempt distributions 24.17 CTA 2010, s 1077(1)(a)(ii) refers to a distribution consisting of the transfer by a company of shares in one or more of its 75 per cent subsidiaries to one or more transferee companies, which then issue shares to any or all of the members of the distributing company (see Figure 24.3). Figure 24.3 Indirect demergers – CTA 2010, s 1077(1)(a)(ii)

These transactions are both referred to as ‘indirect demergers’, with the second version, a transfer of a 75 per cent subsidiary to a transferee company, being the most common, not least because a trade transfer can be fairly easily

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24.17 Exempt distributions structured this way by hiving down the trade and assets to a new subsidiary of the group prior to carrying out a CTA 2010, s 1077(1)(a)(ii) demerger. In the main, however, these transactions have always been able to qualify for the various capital gains reliefs at both corporate and shareholder level, which is why they were originally more popular than direct demergers. Each of these forms of demerger must also satisfy the further requirements of CTA 2010, ss 1081, 1083 and 1085. There has been a great deal of debate, both privately and in the tax press, on the question of whether a transfer of an asset, be it a trade or shares, to a nongroup company in this way is, in fact, a distribution at all. From a company law perspective, the distribution is not being made directly to the shareholders of the company and CA 2006, s 830 provides that a distribution is by a company to its members. However, case law construes the meaning of ‘distribution’ widely to include situations where value is passed by a company indirectly to its members by a series of steps, most notably in Aveling-Barford Limited v Perion Limited [1989] BCLC 626. While there is no clear link between the definitions of distributions for company law reasons and its meaning for tax purposes1, it is not obvious from the tax legislation that such a transaction is a distribution for tax purposes, either. It is the view of HMRC, as evidenced by this particular legislation, that such transactions do constitute distributions. HMRC’s position is that a distribution in specie of the appropriate assets is made in favour of the shareholders and that the shareholders direct that the transfer actually be made to the transferee company in return for the issue of shares, rather than being made directly to them. While commentators may disagree with the detail of this analysis, the legal documentation in respect of such transactions is frequently couched in these terms2. Whichever way the argument falls, it is of course unlikely that anyone would consider carrying out such a transaction on the basis that it is not in law a distribution when such a conveniently structured exemption from tax is available.

1 In fact, the word ‘distribution’ was first used in tax legislation in 1965 when corporation tax was introduced but did not appear in company law until CA 1985. 2 The authors also understand that the ICAEW’s guidance on distributions – Guidance on realised and distributable profits under the Companies Act 2006, Tech 02/17BL – agrees that such a ‘sideways distribution’ is lawful, whether to a sister subsidiary or to another company with common shareholders.

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Exempt distributions 24.18 Technical issues 24.18 The transactions which comprise the transfer of a subsidiary – CTA 2010, ss 1076, 1077(1)(a)(ii) – specifically require that that subsidiary be a 75 per cent shareholding. CTA 2010, s 1099 tells us that this must be a directly held shareholding of the distributing company. Putting these together, clearly, the distributing company’s holding in the company to be distributed must be at least 75 per cent directly held. That said, it is also a point of company law that a company can only distribute its directly owned assets, it cannot distribute the assets of its subsidiaries. This is, of course, not a matter of company law, it is simply a question of title. In practical terms, this means two things: ●●

first, it is necessary to transfer the subsidiary concerned to the principal company in the group, which will be the distributing company, before carrying out the demerger. This can be done by a series of exempt distributions, as made clear by CTA 2010, s 1085, but ordinary distributions within a group will also be tax-free in most cases, by virtue of CTA 2009, Part 9A; and

●●

secondly, any ‘split’ shareholdings around the group will need to be consolidated under the principal company1.

The first of these steps is very commonly seen in demergers and, so long as the transactions within the group are themselves lawful (for example, taking into account the distributable reserves of each distributing company), HMRC does not see such a preliminary reorganisation of a group as offensive. The second scenario is less common but is again considered inoffensive by HMRC. Indeed, subject to the caveats discussed later relating to non-75 per cent group shareholdings and non-UK subsidiaries, HMRC has in our experience also always accepted the insertion of a new sub-holding company as the demerger vehicle to be a perfectly acceptable way to structure a demerger. Overall, from our experience of demergers, HMRC does not generally consider any of the above preliminary steps to be part of a scheme or arrangements to avoid tax (see CTA 2010, s 1081(5)(a), below). An area which does cause difficulties is where the company to be demerged is a sub-holding company that owns shares in a number of other companies where the holdings are not all 75 per cent or more (see Figure 24.4). If the majority of sub-holdings are 75 per cent shareholdings, this should not be a problem: HMRC will generally accept that the overall intention is to demerge 75 per cent shareholdings and the fact that some of the shareholdings at the sub-subsidiary level are actually less than that may not create a problem.

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24.18 Exempt distributions Figure 24.4

What if the majority of the holdings are less than 75 per cent? If all or the majority of the sub-holdings are less than 75 per cent, there is a greater likelihood that HMRC will refuse clearance on the ground that, although a 75 per cent subsidiary is to be distributed, the actual trading activities are not 75 per cent owned. HMRC’s approach is likely to be governed by whether it is thought that the structure was put in place simply to comply with the terms of CTA 2010, ss 1076 and 1077, that a 75 per cent subsidiary is required, or whether the structure has been in place for a long time. If the parent company has a number of sub-75 per cent shareholdings and a 75 per cent sub-holding company is inserted for the purposes of being able to carry out an exempt distribution, clearance will almost certainly be refused on the basis that the prior restructuring is carried out purely to bring the group within CTA 2010, ss 1076 and 1077 and that such a transaction is, of itself, offensive and fails the test at CTA 2010, s 1081(5)(a), the tax avoidance motive. On the other hand, if the structure has been in place for some considerable time, HMRC might not find the structure objectionable. This particular concern has caused difficulties in the past with multi-national corporations, as there are a number of countries where local law often requires that foreign-owned companies must have a substantial local shareholding. Imagine a multi-national group which wishes to demerge part of its business where the shareholdings in the relevant companies are generally less than 75 per cent due to the local ownership rules. If there is already a wholly owned UK resident sub-holding company for the non-UK shareholdings, it may be possible to persuade HMRC that a demerger should be permitted. If, however, it is necessary to insert such a company, HMRC is more likely to take the view that the company is inserted solely to get within the technical terms of the legislation, and clearance has, in our experience, often been refused on that basis.

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Exempt distributions 24.20

1 There is an interesting company law point here; all companies, other than private limited companies, are required to have two shareholders, although there is no minimum number of shares that the second shareholder is required to hold. If any of the subsidiaries are public limited companies or unlimited companies, it may be necessary to arrange that another group company holds a single share on trust for the major shareholder. This was the reason for the single shareholding in the Young, Austen & Young case, for example.

CTA 2010, s 1078 – division of business in a cross-border transfer 24.19 ‘(1) This section applies to a distribution which consists of– (a) the transfer of part of a business by a company to one or more other companies (“the transferee company or companies”), and (b) the issue of shares by the transferee company or companies to the members of the company making the transfer. (2) A distribution to which this section applies is an exempt distribution if either– (a) each of the tests in paragraphs (a) to (f) of section 140A(1A) of TCGA 1992 (cross-border transfers: division of UK business) is met in relation to it, or (b) each of the tests in paragraphs (a) to (e) of section 140C(1A) of TCGA 1992 (cross-border transfers: division of non-UK business) is met in relation to it.’ This provision covers transactions of the same form as shown in Figure 24.2 but where the transfers involve branches and/or companies in different EU Member States. This is covered in detail in Chapter 26. CTA 2010, s 1079 – ‘the distributing company’ 24.20 ‘References in this Chapter to the distributing company are– (a) in the case of a distribution falling within paragraph (a) of section 1076, to the company that makes the transfer of shares mentioned in that paragraph, (b) in the case of a distribution falling within section 1077(1), to the company that makes the transfer mentioned in section 1077(1)(a), and (c)

in the case of a distribution falling within section 1078(1), to the company that makes the transfer of part of a business mentioned in section 1078(1)(a).’ 503

24.21 Exempt distributions Analysis 24.21 This provision defines ‘the distributing company’ for the purposes of the exempt distributions legislation. Broadly, the distributing company is the company making the distribution that may be exempt. Under CTA 2010, s 1076, this is the company distributing shares in 75 per cent subsidiaries; under CTA 2010, s 1077, this is the company distributing either trading activities or shares in 75 per cent subsidiaries; under CTA 2010, s 1078, this is the company transferring part of a business. CTA 2010, s 1080 – meaning of ‘relevant company’ 24.22 ‘(1) This section gives the meaning of “relevant company” in this Chapter. (2) In the case of a distribution falling within section 1076(a) the relevant companies are– (a) the distributing company, and (b) each subsidiary whose shares are transferred as mentioned in section 1076(a). (3) In the case of a distribution falling within section 1077(1), the relevant companies are– (a) the distributing company, (b) each transferee company mentioned in section 1077(1)(a), and (c)

each subsidiary whose shares are transferred as mentioned in section 1077(1)(a)(ii).

(4) In the case of a distribution falling within section 1078(1), the relevant companies are– (a) the distributing company, and (b) each transferee company mentioned in section 1078(1)(a).’ Analysis 24.23 This provision defines a ‘relevant company’ for the purposes of the exempt distributions legislation. Broadly, a relevant company encompasses the distributing company, any company of which the shares are distributed in a transaction within CTA 2010, ss 1076 and 1077(a)(ii), and each transferee company referred to in CTA 2010, ss 1076–1078.

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Exempt distributions 24.26 CTA 2010, s 1081 – the general conditions 24.24 CTA 2010, s 1081 explains conditions A to D, which apply to all demergers within CTA 2010, ss 1076 and 1077 (but not, as already noted, demergers under CTA 2010, s 1078). Recent commentaries have questioned the continued need for the detailed conditions in CTA 2010, ss 1081–1085. Some of them were intended to prevent abuse or avoidance of the rules on advance corporation tax (‘ACT’), which was repealed in FA 1998. Some of them have, frankly, no obvious purpose, even when viewed in the context of the ACT regime. Representations have been made that exempt distributions should be permitted as long as the demerger satisfies the tests in TCGA 1992, s 137(1), ie being for commercial purposes and not part of tax avoidance arrangements. This would remove the need for the detailed and complex conditions in CTA 2010, ss 1081–1085 and permit genuinely commercial transactions to be carried out by the relatively simpler mechanism of a distribution in specie. CTA 2010, s 1081(1) – the residence requirement 24.25 ‘(1) Condition A is that each relevant company must be resident in a Member State at the time of the distribution.’ Analysis 24.26 This imposes the condition that each relevant company (as defined at CTA 2010, s 1080) be a resident company of an EU Member State. In general terms, this means it must be incorporated in an EU Member State (for States where incorporation determines residence, such as the UK (see 4.36)), have its central control and management in an EU Member State (the general rule under the OECD Model Treaty) or is resident in a Member State through some other law of that jurisdiction determining company residence. There is further discussion of this provision in Chapter 26. The provision previously required that the relevant companies must be resident in the UK at the time of the distribution, but it was changed by SI 2009/2797 with effect from 11 November 2009, to comply with the requirements of the EU Mergers Directive. Whether this condition will survive Brexit is a matter for surmise at the time of writing, although it will remain in place until and unless it is repealed or amended by Parliament. This requirement should not present insurmountable difficulties in the majority of domestic cases. Not surprisingly, however, this has led to a number of interesting issues in considering demergers involving multinational groups. Although these situations arose when the requirement was to be UK resident (which was the case before 11 November 2009), the following discussions will still be relevant if the references to the UK are now read as references to a Member State. 505

24.26 Exempt distributions The most common scenario was where a group had a number of subsidiaries which were not UK resident (see Figure 24.5). If the majority of the subsidiaries were UK resident, the mere fact that some were not should not have prevented clearance being granted for the demerger. But if the majority of the group’s subsidiaries were not UK resident, and the UK resident sub-holding company only owned non-UK resident subsidiary companies, the issues were similar to those outlined above for non-75 per cent subsidiaries. Regardless of how long the situation had been in place, HMRC could refuse clearance on the ground that the intention, while being a demerger of a UK resident company, was actually to demerge what were mainly non-UK resident trading activities. Clearance would almost certainly have been refused if a UK resident subholding company was inserted in order that the condition of CTA 2010, s 1081(1) be satisfied. Again, the ground for refusal would be that HMRC takes the view that the restructuring of a group for no reason other than to bring it within the technical ambit of these provisions is, in and of itself, abusive. Therefore, the insertion of a UK, now, an EU-resident sub-holding company merely to comply with CTA 2010, s 1081(1) would be seen to fail the tax avoidance test at CTA 2010, s 1081(5)(a). Figure 24.5

On the other hand, if the structure has clearly been in place for some time and was not put in place to facilitate the demerger, HMRC may grant clearance, depending on the other surrounding circumstances. Another area of interest is where a company is EU resident as well as being tax resident in another, non-EU, jurisdiction, however this may arise. In the main, it is doubtful that HMRC would have grounds to refuse clearance if the distributing company or the company being distributed were, and for some time had been, dual resident in this way. HMRC would, of course, nevertheless be entitled to satisfy itself that the companies are indeed tax resident in an EU Member State at the time of the transaction. Of perhaps more interest is the situation where the transferee company is dual resident, as the transferee company is almost invariably a company set up

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Exempt distributions 24.28 specifically for the purpose of the demerger transaction. Of course, HMRC is entitled to ensure that the company is actually EU resident at the time of the transaction for tax purposes, but HMRC has also previously taken the view that, where the requirement was for the company to be UK resident, it was entitled to ensure that the company remained UK tax resident for a reasonable time after the demerger transactions. The grounds for this were that, otherwise, a dual resident company might have been set up purely to be tax resident for the single moment of the transaction and not thereafter. This would be again considered to offend against CTA 2010, s 1081(5)(a) and clearance for the transaction would be refused. That this has occurred in the past is a matter of public record. When the Millennium Chemicals group was demerged from Hanson plc in 1996, it was a requirement of the clearance granted by HMRC that the dual resident holding company of Millennium Chemicals, the transferee company in the demerger, remain UK tax resident for a period of five years after the demerger. There was substantial press reporting of the fact that this required the Chief Executive Officer of the group, who was based in the USA, to fly to the UK on a fortnightly basis for board meetings in Grimsby. It is interesting to note that the legislation only discriminates on the basis of the residence of the relevant companies, not on the basis of the place where the trade is carried on, the situs of the relevant economic activity. There is nothing to prevent a UK resident trading company from qualifying for the exemption even if the trade is carried on wholly outside the UK. In our experience, this is a rare scenario, however, and we are guessing that the policy here, if it has ever been explicitly considered, is that there is little risk of any material loss to the UK Exchequer by permitting such demergers. CTA 2010, s 1081(2) – the activity requirements 24.27 ‘(2) Condition B is that at the time of the distribution– (a) the distributing company must be either a trading company or a member of a trading group, and (b) each subsidiary whose shares are transferred as mentioned in section 1076(a) or 1077(1)(a)(ii) must be either a trading company or the holding company of a trading group.’ Analysis 24.28 This subsection contains the requirement relating to the activities of the distributing companies and of the companies demerged under CTA 2010, ss 1076 and 1077. 507

24.28 Exempt distributions First, for all exempt demergers, the distributing company must be a trading company or a member of a trading group. In practice, this almost always means that it is either a trading company itself or the ultimate parent company of a trading group. (Strictly, of course, the distributing company might be a 75 per cent subsidiary within a trading group and thus merely be a member of the group, but CTA 2010, s 1085 would then require a further demerger transaction by that parent company of the interim transferee company. This is discussed further below.) Secondly, the subsidiary company demerged under CTA 2010, ss 1076 and 1077 must also be either a trading company or the holding company of a trading group. For the purposes of this legislation, CTA 2010, s 1099(1) defines a holding company as one whose business consists wholly or mainly (disregarding its own trading activities) of holding shares or securities in companies which are its 75 per cent subsidiaries. CTA 2010, s 1099(1) defines a trading company as one ‘whose business consists wholly or mainly of carrying on a trade or trades’ and a trading group is ‘a group the business of whose members (taken together) consists wholly or mainly of carrying on a trade or trades’. There is no definition of what is meant by ‘wholly’ or ‘mainly’ and there is no suggestion that the 20 per cent test that HMRC applies to the substantial shareholding exemption and business asset disposal relief (formerly known as ‘entrepreneurs’ relief’) would apply in this case. In the main, however, experience suggests that HMRC takes a reasonably sensible view as to what is a trading activity and what is ‘wholly’ or ‘mainly’ trading in the cases where companies have mixed activities such as investment activities and trades. While no specific guidance is supplied to taxpayers in this area in respect of the demergers legislation, we would normally expect to see HMRC looking at the now relatively well-known tests relating to balance sheet values of assets, contributions to income and management time required. For example, if there is a property with a high value on the balance sheet, but contributing relatively small proportions of the gross income of the company and not requiring much management time, this should not disqualify the company or group from qualifying as trading. This sort of approach would be in line with the detailed guidance provided by HMRC for the purposes of the substantial shareholding exemption and taper relief. As we have already seen, there is an interesting distinction here. Under the UK domestic legislation, a demerger or partial division is only able to use the relevant reliefs from tax if the business being divided is a trade. But the EU legislation refers to partial divisions of the ‘activities’ of a company, so that the UK legislation implementing the Mergers Directive talks about partial division of a ‘business’. As a result, the EU-based legislation gives a wider scope for EU cross-border demergers than the UK legislation does for domestic 508

Exempt distributions 24.30 demergers. This is, arguably, another area where the legislation could be made more internally consistent if it were considered as a whole, rather than being amended piecemeal. CTA 2010, s 1099(1) also states that dealing in shares, securities, land, trades or commodity futures are not trades for this purpose. While the authors can see some scope for abuse here, it does seem a little unreasonable that an entity that is treated as trading in shares and securities for the purposes of computing its trading profits will not be treated as trading for the purposes of being able to carry out a demerger by this route. Similar comments could be made about trading in land as well. It is, however, helpful that HMRC accepts property development as a trade that can qualify under CTA 2010, s 1081(2), so it is assumed that what is referred to in the exclusion in CTA 2010, s 1099 is the buying and selling of land without any development work being carried out. CTA 2010, s 1081(3) – the benefits test 24.29 ‘(3) Condition C is that the distribution must be made wholly or mainly for the purpose of benefiting some or all of the trading activities which– (a) before the distribution are carried on by a single company or group, and (b) after the distribution will be carried on by two or more companies or groups.’ Analysis 24.30 This is the provision which requires that there be an anticipated commercial or trading benefit to one or more of the trades to be separated. There are a number of points worth making here. First, it is not necessary to demonstrate that both or all of the trades to be separated will be specifically benefited. It is only necessary to demonstrate that at least one of the trading activities will be commercially benefited by the demerger. For example, a company carries on a trade and starts up a new, related activity that is wholly speculative. The board realises that the potential commercial liabilities in respect of this activity are such that they would prefer that this speculative activity be separated from the main trading group by way of demerger. It would be reasonable to assume that the anticipated benefit is to the previously existing trade by virtue of a potential commercial liability being removed from the same corporate group. There is no obvious commensurate benefit to the demerged activity, but this is not necessary under the terms of CTA 2010, s 1081(3). 509

24.31 Exempt distributions Arguably, a demerger might be acceptable to HMRC even if the demerger is demonstrably to the detriment of one of the other trading activities. One would assume that HMRC would consider each case on its merits at the appropriate time. Perhaps a slightly better answer is to say that the bare words of CTA 2010, s 1081(3) do not preclude such a possibility, so long as the disadvantaged activity is expected to remain viable, so as not to breach the condition of CTA 2010, s 1081(5)(e) (ceasing the trade, see below). Where the disadvantage to an activity is such that the activity would almost inevitably fail or have to be sold on subsequently, it seems likely that the conditions of CTA 2010, s 1081(5)(d) or (e) might be invoked. CTA 2010, s 1081(4) to (7) – anti-avoidance 24.31 ‘(4) Condition D is that the distribution must not form part of a scheme or arrangement to which subsection (5) applies. (5) This subsection applies to any scheme or arrangement the main purpose or one of the main purposes of which is– (a) the avoidance of tax, (b) the making of a chargeable payment (see section 1088), (c)

the making, in pursuance of a scheme or arrangements with a company (“A”) or with any of its main participators, of what would be a chargeable payment if A were an unquoted company,

(d) the acquisition by any person or persons, other than the members of the distributing company, of control of– (i)

the distributing company,

(ii) any other relevant company, or (iii) any company which belongs to the same group as the distributing company or any other relevant company, (e)

the cessation of a trade after the distribution, or

(f)

the sale of a trade after the distribution.

(6) Subsections (5)(b) and (c) are without prejudice to the width of subsection (5)(a). (7) In subsection (5)–

“group” means a company which has one or more 51% subsidiaries together with those subsidiaries,

“main participators” has the meaning given by section 1089(1)(b), and

“tax” includes stamp duty and stamp duty land tax.’ 510

Exempt distributions 24.32 Analysis 24.32 These are the main anti-avoidance provisions within the demergers legislation. Essentially, this gives the motives which are not permitted to be the whole or one of the main drivers behind the proposed demerger. HMRC has offered no general guidance on the meaning of the words of CTA 2010, s 1081(4). Nor is it clear how important any of these specific purposes within CTA 2010, s 1081(5) has to be at the time the transaction is anticipated for it to constitute a main purpose. To a large extent, this will be a question of fact and degree and will need to be considered by the inspector in the context of every individual case. It is also probably fair to say that the inspector would be entitled to ask for any evidence that may exist in support of any arguments put forward by a company or group. It is, however, worth noting two possible interpretations of the concept of ‘one of the main purposes’ that are generally considered apposite by HMRC. There are also a number of cases in the context of the transactions in securities legislation, which might be useful guidance as to the border between a main purpose and an ancillary purpose in this context. First, if a transaction is materially driven by one of the purposes in CTA 2010, s 1081(5), then most readers will probably agree that that might well constitute a main purpose, even if not the main purpose, of a transaction. For example, if there is a strong need to separate businesses for commercial purposes, but also an intention to sell or list one of the businesses at some future time, the second intention might be considered to be a main, albeit subsidiary, purpose of the transaction. Secondly, however, HMRC also takes the view that something that is inevitable must also be one of the main purposes of the transaction. For example, it might be that a business to be demerged obviously cannot exist as a viable stand-alone business and that it is, therefore, almost inevitable that it will either close or have to be sold or merged with some other business. In that case, HMRC will take the view that the closure or merger of that business, being an inevitable consequence of the demerger, must be one of its main purposes. There is another thread to the meaning of the word ‘arrangements’. HMRC has in the past taken the view that arrangements over a very long term, or which are so hedged with uncertainty and contingency as to be virtually meaningless, do not necessarily contravene CTA 2010, s 1081(5) (see the second scenario under CTA 2010, s 1081(5)(d) below). In practical terms, of course, it is imperative in any clearance application to make full disclosure of all future plans, however vague and however long term, in order to ensure that any HMRC clearance is granted in full knowledge of all

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24.33 Exempt distributions relevant facts, so that it can be relied upon as properly valid. Further guidance in this area is given below (Clearances) and also in Chapter 14. CTA 2010, s 1081(5)(a) – the tax-avoidance motive 24.33 The first purpose which is denied by CTA 2010, s 1081(4) is, not surprisingly, that of the avoidance of tax. In this context, CTA 2010, s 1119 tells us that this refers to income tax or corporation tax. CTA 2010, s 1081(7), however, also specifically includes stamp duty or stamp duty land tax, here. It would appear, therefore, that ‘tax’ does not include capital gains tax or corporation tax on chargeable gains. This would appear to be a reasonable view to hold, especially given that there is no obvious way to avoid corporation tax on chargeable gains in transactions within this chapter. There are two reasons for this: ●●

any transaction within CTA 2010, s 1076 is a disposal for the purposes of corporation tax on chargeable gains anyway, subject to the availability of the substantial shareholding exemption, so the demerger does not avoid corporation tax on chargeable gains. Nor is there likely to be avoidance at shareholder level as the transaction is treated as a reorganisation (see TCGA 1992, s 192 below), so there is no up-lift to shareholders’ base cost; and

●●

any transaction within CTA 2010, s 1077 should also be a reconstruction, such that any perceived avoidance of corporation tax on chargeable gains would be reviewed under the appropriate capital gains legislation. For example, if a company is demerged and therefore leaves a group holding a chargeable asset transferred to it within the previous six years, there is a rebasing of the asset caused by the degrouping legislation, but no tax charge (see 1.10 et seq). If this is an important purpose of the demerger, this element should be picked up when HMRC considers the anti-avoidance requirements of TCGA 1992, s 137(1) (see 13.7 et seq).

One area which HMRC takes very seriously in the context of avoidance of tax is where preliminary transactions are carried out to bring a potential demerger within the scope of the exempt distributions legislation. Where a demerger by way of distribution would not naturally fall to qualify under these provisions, so that the preliminary arrangements are carried out purely so that the benefit of the exemption will be available, it is likely that HMRC would invoke CTA 2010, s1081(5)(a). Examples include those given in the discussions of CTA 2010, s 1081(1) and (2), above. HMRC also objects to extra steps being bolted onto a straightforward demerger in order to generate an unwarranted (in its view) further tax advantage. For example, the authors have seen situations where the share capital of a company 512

Exempt distributions 24.35 was converted into non-sterling denominated bearer shares (the so-called ‘Dollar Bearer’ share scheme) in order to avoid the stamp duty charge that would otherwise have applied. In that scenario, clearance was refused on the ground that, while the transaction was not intended specifically to avoid stamp duty, the bolting on of further steps to the demerger clearly meant that there was a main purpose (albeit not the main purpose) of avoiding stamp duty. While the specific scheme mentioned no longer works to avoid stamp duty, the principle remains. CTA 2010, s 1081(5)(b) and (c) – making chargeable payments 24.34 This is a fairly obscure provision whereby one of the purposes of the transaction must not be the making of a payment that would be a ‘chargeable payment’, as defined by CTA 2010, s 1088, or a payment that would be such a payment if the companies involved were unquoted. The detail of what is meant by a ‘chargeable payment’ will be considered in due course. However, it is important to note that, while CTA 2010, s 1086 only applies to chargeable payments made in the period of five years immediately following a demerger transaction, CTA 2010, s 1081(5)(b) does not have this five-year time limit. The authors are not aware, however, of this provision having been invoked in respect of any of the demergers which they have experienced. Note also that CTA 2010, s 1081(6) specifically states that these provisions relating to chargeable payments are without prejudice to the width of the tax avoidance test at CTA 2010, s 1081(5)(a). CTA 2010, s 1081(5)(d) – change of control 24.35 The intention here is to prevent the use of the demerger legislation to facilitate the onward disposal of any relevant company – the distributing company, any company distributed or any transferee company – or of any company that is a member of the same group as any relevant company. Note that the definition of ‘group’ for the purposes of this subsection is of a company and its 51 per cent subsidiaries, not just 75 per cent subsidiaries as for the rest of this legislation (see CTA 2010, s 1081(7)). The ‘mischief’ that HMRC is trying to prevent is a tax-free demerger followed by a disposal of one of the demerged companies or groups. Instead of there being a corporation tax charge on the chargeable gain at corporate level, followed by the shareholder-level charge when the disposal proceeds are distributed, the demerger will have ensured that there is only one tax charge, at shareholder level. Of course, with the substantial shareholding exemption now likely to be available in most cases, this is far less likely to be a tax-avoiding scenario than previously, as there would now only be one level of tax charge,

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24.35 Exempt distributions on the distribution of profits to the shareholders. But, even now, the tax charge might be lower if there were a disposal directly by the shareholders due to the availability of business asset disposal relief (formerly known as ‘entrepreneurs’ relief’) to take the rate down to 10 per cent. One might argue that the avoidance of tax in such a scenario is sufficient to invoke CTA 2010, s 1081(5)(a) and that CTA 2010, s 1081(5)(d) is otherwise unnecessary. While this might be true in many circumstances, it may not always be the case. It is also clear from documents published at the time that government policy in respect of this legislation was to benefit trading activities in the circumstances where a demerger, not a disposal, was considered the preferred commercial option. It was never the intention that the legislation be available to facilitate the disposal of trading activities to third parties. Other scenarios which we have seen where CTA 2010, s 1081(5)(d) was relevant include: ●●

a company carried on two very different activities and wished to separate them for what appeared to be perfectly commercial reasons. However, two of the shareholders of the distributing company, who were between them taking one of the trading activities, had only subscribed for their shares some four or five months prior to the application for demerger clearance. It was the view of HMRC that these persons had subscribed for shares in the company so that, on applying for the clearance, CTA 2010, s 1081(5)(d) would not be breached as the individuals concerned would already be members of the company at the date of demerger. HMRC’s view, therefore, was that CTA 2010, s 1081(5)(a) was breached instead, as this was an example of a company reorganising in such a way that it could satisfy the conditions of CTA 2010, s 1081, when otherwise the demerger was bound to breach one of those conditions;

●●

a demerger clearance was requested such that two individuals who ran a company could instead run their separate parts of their business as separate trades in separate companies. Part of the rationale behind this transaction was the ability for each individual to leave the appropriate part of the business to his son on death or retirement. The individuals concerned were in their early 40s and had no intention of retiring for at least another 15 years at the time of application. This might, prima facie, appear to have as part of its intention the ability to pass the businesses onto persons who were not at the time of the demerger members of the distributing company. However, HMRC took the view that an event that may or may not happen some 15 or more years hence could not constitute a ‘scheme or arrangements’ which contravened CTA 2010, s 1081(5)(d). Of course, if the original shareholders were intending to retire in, say, two years’ time, HMRC would have been within its rights to conclude that the demerger did, indeed, fail the test at CTA 2010, s 1081(5)(d); 514

Exempt distributions 24.35 ●●

an application was made to demerge a company from a group for genuine commercial reasons. The demerged entity would not stand alone, but would in fact end up 50 per cent owned by a third party as part of a joint venture structure. Prima facie, the inevitability that this demerged entity would have to join with a third party in order to remain viable might apparently mitigate against the granting of a clearance. However, it was accepted by HMRC that a 50:50 joint venture meant that control had not technically passed to a person who was not a member of the group at the time of the demerger. Although control no longer sat with the original members of the distributing company, the legislation was only concerned with whether control had passed to someone else. Clearance was granted;

●●

a large multinational group requested a demerger clearance as part of a worldwide separation of its two major activities (the CTA 2010, s 1085 implications will be considered shortly). The result would have been two separate worldwide groups and one of those would have immediately merged with a third party group to create a much larger and more viable entity. It was also clear that the value and shareholder base of the demerged entity would have been such that that group was now under the control of the larger group. However, both groups were publicly quoted in the country of residence and it was demonstrated to the satisfaction of HMRC that there was substantial commonality of membership of the two groups. As a result, it could not be said either that control had passed to persons who were not members of the distributing group at the time of the demerger or that this was an intention of the scheme. Again, clearance was granted;

●●

in cases involving publicly listed companies it is always possible that the shareholder base of either the distributing company or of the demerged entity might change substantially immediately following relisting of the demerged groups. It was accepted by HMRC, however, that the behaviour of the shareholder of a listed company is a matter outside the control of that company. Therefore, since it was no part of the intention of the companies carrying out the demergers that there be any major change in the shareholder base of either post-demerger group so there could be no scheme or arrangements within CTA 2010, s 1081(5)(d), clearances were granted. We accept, of course (as does HMRC, no doubt), that there might be rare occasions where the demerger of a public company is being carried out partly to facilitate a wholesale change in the shareholder base. In such a case, CTA 2010, s 1081(5)(d) might indeed be in point.

It is, perhaps, instructive to compare CTA 2010, s 1081(5)(d) with the practical application of the anti-avoidance provisions in TCGA 1992, s 137(1). The authors frequently come across scenarios where a demerger of the trading activities of a company are not necessarily compatible with a single trade sale: the disparities between the trades are such that they are best sold separately.

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24.36 Exempt distributions We would argue that it is commercially sensible to demerge the activities some time before deciding to market the companies for sale, but the intention to sell is clearly a main purpose (if not the main purpose) for the demerger, so a CTA 2010, s 1081(5)(d) distribution cannot be used. However, a demerger by another mechanism is considered completely acceptable, so we are forced into a more complex mechanism, with commensurately greater cost, for no obvious policy reason. CTA 2010, s 1081(5)(e) and (f) – cessation or sale of trade 24.36 This provision is in line with the original policy that demergers under this provision be available to assist with the trading activities of groups and with separating those trading activities to permit more efficient trading. It was not intended to allow companies to separate trading activities such that one or other of those could either be sold or closed down without having an adverse effect on the other. The authors’ experience is that this provision is rarely invoked, although CTA 2010, s 1081(5)(e) has been considered in the context of demergers where one or other of the entities might not be viable as a stand-alone business. CTA 2010, s 1082 – conditions relating to direct demergers only 24.37 ‘(1) Condition E is that the shares mentioned in section 1076(a)– (a) must not be redeemable, (b) must constitute the whole or substantially the whole of the distributing company’s holding of the ordinary share capital of the subsidiary, and (c)

must confer the whole or substantially the whole of the distributing company’s voting rights in the subsidiary.

(2) Condition F is that the distributing company must after the distribution be either– (a) a trading company, or (b) the holding company of a trading group. But see subsections (3) and (4). (3) Condition F need not be met if the distributing company is a 75% subsidiary of another company. (4) Condition F need not be met if– (a) the transfer mentioned in section 1076(a) relates to two or more 75% subsidiaries of the distributing company, and 516

Exempt distributions 24.38 (b) the distributing company is dissolved without there having been after the distribution any net assets of the company available for distribution on a winding up or otherwise.’ Analysis 24.38 This provision refers only to direct demergers. The shares of the subsidiary to be transferred directly to the shareholders must not be redeemable shares, they must constitute the whole or substantially the whole of the holding of the ordinary share capital of the subsidiary and of the distributing company’s voting rights in the subsidiary (condition E). And, following the transaction, the distributing company must be a trading company or the holding company of a trading group (condition F). Taking each of these in turn, condition E is that the shares distributed to shareholders must not be redeemable shares. This means that if there are redeemable shares in place prior to the demerger, these will have to be dealt with in some way prior to the transaction occurring. In the main, HMRC seems to accept that such shares can be redeemed (provided that the articles of association of the company permit) or bought back prior to the demerger or sold or distributed in taxable form separately to the shareholders. Alternatively, it may be that they can be left in place, subject to the other conditions still being satisfied. Of course, the hypothetical redeemable shares mentioned above will very often be fixed rate preference shares and therefore will not be part of the ordinary share capital. In such a case, a demerger of the entire ordinary share capital, so long as this also constitutes at least 90 per cent of the voting rights, would satisfy the CTA 2010, s 1082 test even if the redeemable shares are left in place between the parent and the now ex-subsidiary. The bigger issue is that it appears that a distribution of all of a company’s shares would only be an exempt distribution to the extent that those shares are not redeemable. If the value of the redeemable shares were to be treated as an income distribution, this will encourage the parties to consider redeeming the shares before the demerger. This is another distinction between exempt distributions and other demerger structures, as the reliefs in TCGA 1992, s 136 for a scheme of reconstruction can apply to all a company’s shareholders and even debenture holders (see 18.2 et seq). The shares distributed must also constitute ‘the whole or substantially the whole’ of the distributing company’s holding of ordinary share capital and of its voting rights in the subsidiary company. HMRC states in Statement of Practice 13/1980, and has confirmed verbally since then, that the phrase ‘whole or substantially the whole’ shall be taken to mean at least 90 per cent. So it is

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24.38 Exempt distributions possible to carry out a direct demerger with the distributing company retaining a 10 per cent stake (or, more accurately, a holding which is 10 per cent of its pre-transaction shareholding). Clearly, the 90 per cent figure is only HMRC’s opinion and potentially a safe harbour, so if a demerger has to be carried out with only 85 per cent of the shares, for example, this may not be fatal. But it may be difficult to persuade HMRC to give pre-transaction clearance. Condition F is that the distributing company must remain a trading company or the holding company of a trading group following the transaction. This is to prevent a non-trading holding company, for example, a property investment company, being able to carry out a demerger of its single trading subsidiary. This might arise, for example, where, prior to the transaction, a group as a whole qualifies as a trading group for the purposes of CTA 2010, s 1081(2), but, after a demerger of all the trading subsidiaries, the distributing company would be an investment company. So, in essence, exempt distribution treatment is only available for the separation of trading activities, as discussed above, and not for the separation of trading and non-trading activities. The transaction cannot be structured the other way, with a distribution of the non-trading company instead, because this would mean that the company being demerged is not a trading company in contravention of CTA 2010, s 1081(2)(b), discussed above. The requirements relating to the distributing company after the demerger are suspended in two circumstances. ●●

Where the distributing company is itself a 75 per cent subsidiary of another company, CTA 2010, s 1082(3) suspends this requirement, as there are special rules at CTA 2010, s 1085, requiring a series of demergers until a final demerger by the ultimate parent company discussed further below.

●●

Where it is to be dissolved (presumably, whether this be by liquidation or without liquidation, under CA 2006, s 900) after distributing all its trading subsidiaries, CTA 2010, s 1082(4) applies.

CTA 2010, s 1082(4) applies if the distributing company distributes the shares of all of its 75 per cent subsidiaries so that it does not have any net assets available for distribution. So long as the company is then dissolved, the demerger can still qualify as an exempt distribution. It is not clear whether this provision was intended to cover dissolutions without winding up, under CA 2006, s 900, where this is possible under UK company law (ie non-partition demergers that can be schemes of reconstruction (Chapter 22)). However, it is of course possible to carry out a demerger by exempt distribution, followed by liquidation of the distributing company, and CTA 2010, s 1082(4) would potentially apply to such a sequence of transactions.

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Exempt distributions 24.39 In practice, of course, it is not possible for the distributing company to be left without ‘any net assets of the company available for distribution in a winding up or otherwise’ as company law requires there to be at least the minimum amount of share capital in place1. However, HMRC’ has issued Extra-Statutory Concession C11 in which it accepts a negligible amount of assets available for distribution in winding up, up to a maximum of £5,000. It is to be noted, however, that HMRC takes this upper bound to be sacrosanct and is unlikely to give clearances for transactions where shell companies will be left under these circumstances with any greater amounts of share capital. The authors are also aware of an HMRC challenge as to when the company is to be wound up. HMRC occasionally seems to struggle with the fact that the company may need to pay off creditors and wind up its affairs in an orderly fashion, rather than simply ceasing to exist!

1 One share, in the case of a private limited company, and two shares in the case of all other companies, provided that, in the case of a public limited company, the company is not trading in any way, in which case it must have £50,000 of share capital which must be at least a quarter paid up.

CTA 2010, s 1083 – detailed conditions for indirect demergers under CTA 2010, s 1077 24.39 ‘(1) Condition G is that if a trade is transferred, the distributing company must either– (a) not retain any interest in that trade, or (b) retain only a minor interest in it. (2) Condition H is that if shares in a subsidiary are transferred those shares– (a) must constitute the whole or substantially the whole of the distributing company’s holding of the ordinary share capital of the subsidiary, and (b) must confer the whole or substantially the whole of the distributing company’s voting rights in the subsidiary. (3) Condition I is that the only or main activity of the transferee company, or each transferee company, after the distribution must be– (a) the carrying on of the trade, or (b) the holding of the shares transferred to it.

519

24.40 Exempt distributions (4) Condition J is that the shares issued by the transferee company or each transferee company– (a) must not be redeemable, (b) must constitute the whole or substantially the whole of its issued ordinary share capital, and (c)

must confer the whole or substantially the whole of the voting rights in that company.

(5) Condition K is that the distributing company must after the distribution be either a trading company or the holding company of a trading group.’ CTA 2010, s 1084 – cases where condition K does not apply 24.40 ‘(1) Condition K need not be met if the distributing company is a 75% subsidiary of another company. (2) Condition K need not be met if– (a) there are two or more transferee companies each of which has transferred to it– (i)

a trade, or

(ii) shares in a separate 75% subsidiary of the distributing company, and (b) the distributing company is dissolved without there having been after the distribution any net assets of the company available for distribution on a winding up or otherwise.’ Analysis 24.41 These provisions set out a number of requirements for indirect mergers, which we shall look at in turn. CTA 2010, s 1083(1) – condition G, the minor interest provision 24.42 This provision requires that where a trade is transferred under CTA 2010, s 1077(1)(a)(i), the distributing company can retain no more than a ‘minor interest’ in the trade. The mischief that this provision is aimed at is the situation where a demerger is carried out for reasons that do not involve a real separation of the trades. For example, in Statement of Practice 13/1980, HMRC refers to a company retaining an interest in a trade in which it carries on jointly with the transferee company or has rights to any of the profits or assets of that trade.

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Exempt distributions 24.44 In wider terms, the Statement of Practice notes that a company might also continue to have an interest as a result of normal commercial transactions, such as being a main supplier or customer. HMRC would not normally argue that this was other than a minor interest unless the distributing company effectively had control of the trade, its assets or the profits. The authors have seen this situation on a number of occasions, particularly where, following a demerger, both companies temporarily continue to share head office functions and facilities immediately after the demerger. The Statement of Practice notes that HMRC accepts that it is difficult to quantify an interest in a trade, but, in so far as this can be done, then ‘minor interest’ must be the opposite of ‘substantially the whole’ so that it must be no more than 10 per cent. In practice, the authors have not seen a transaction where this provision is in point. However, where there are likely to be continuing trading relationships, it is recommended that these be disclosed at the same time as the clearance application is made. CTA 2010, s 1083(2) – condition H, provisions relating to the transferred shares 24.43 This provision largely mirrors CTA 2010, s 1082(1) in respect of the shares of a subsidiary being transferred and the comments on that subsection are equally applicable here. However, there is no requirement here that the shares not be redeemable, so if the subsidiary to be demerged has substantial redeemable share capital, CTA 2010, s 1077(1)(a)(ii) might be a better route than CTA 2010, s 1076. CTA 2010, s 1083(3) – condition I, provisions relating to the activities of the transferee company 24.44 This paragraph requires that the transferee has as its only or main activity following the distribution the carrying on of the trade transferred to it or the holding of the shares transferred to it. While the Statement of Practice accepts that the concept of ‘after’ does not mean forever afterwards, if the overall transactions in contemplation were such that it was intended or inevitable that the transferee company has some other activity too, the application of this section might have to be considered. As an example, if a subsidiary is transferred to a transferee company under CTA 2010, s 1077(1)(a)(ii) and it is then intended to hive the trade up to the transferee company, strictly speaking, condition I would not be satisfied, as the whole or main activity of the transferee company would not be the holding

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24.45 Exempt distributions of the shares transferred to it, but would be the carrying on of the trade of that company. Similar comments might apply if the reverse scenario were in contemplation, namely a transfer of a trade under CTA 2010, s 1077(1)(a)(i) and a hive down of that trade into a subsidiary. Another situation which causes concern is where there is a transferee company holding the shares in a company transferred to it in a demerger where the intention is that that company should, in due course, acquire shares in other companies, so the demerger is to be followed by the growth of a group by acquisition. HMRC policy is that the acquisition of other companies will breach the condition that the whole or main activity of the company be the holding of the shares transferred to it in the demerger. Again, depending on the circumstances, it is likely that the application of this subsection will need to be considered with some care. With all respect to HMRC policy advisers, it is difficult to see why any of these situations should be considered offensive, but the law does not grant HMRC any discretion in this area. Nor is there any comment on this point in the explanatory notes to the provisions from 1980. This is unfortunate as the scenarios outlined above have all been seen by the authors and have caused substantial difficulties in being able to carry out demergers that were wholly commercially driven and were otherwise compliant with the provisions of this legislation. CTA 2010, s 1083(4) – condition J, provisions relating to shares issued by transferee company 24.45 This condition mirrors the conditions at CTA 2010, s 1082(1), that the shares to be issued by the transferee company must not be redeemable and must constitute the whole or substantially the whole of both the issued ordinary share capital and the voting rights in that company. This provision ties in with the requirement that the aggregated shareholders after the demerger be the same as before the demerger, that such a policy would be defeated if the shares issued by the transferee company constituted less than 50 per cent of its share capital with the balance held by persons who were not shareholders of the original pre-demerger company or group. CTA 2010, ss 1083(5) and 1084 – condition K, relating to the distributing company 24.46 These mirror CTA 2010, s 1082(2)–(4) above and no further comment is necessary.

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Exempt distributions 24.48 CTA 2010, s 1085 – conditions to be met if the distributing company is a 75 per cent subsidiary 24.47 ‘(1) Condition L is that the group (or, if more than one, the largest group) to which the distributing company belongs at the time of the distribution must be a trading group. (2) Condition M is that the distribution (“the original distribution”) must be followed by one or more other distributions (“further distributions”) falling within section 1076(a) or 1077(1)(a)(ii) which– (a) are exempt distributions, and (b) comply with subsection (3). (3) To comply with this subsection a further distribution must result in members of the holding company of the group (or, if more than one, the largest group) to which the distributing company belonged at the time of the original distribution becoming members of– (a) the transferee company or each transferee company to which a trade was transferred by the distributing company, (b) the subsidiary or each subsidiary whose shares were transferred by the distributing company, or (c)

a company (other than the holding company) of which the company or companies mentioned in paragraph (a) or (b) are 75% subsidiaries.’

Analysis 24.48 CTA 2010, s 1085 is the provision which requires that a group be split up completely to the level at which the distributing company is not a 75 per cent subsidiary of any other company and therefore demonstrates that the demerger rules were not intended to facilitate tax-free separations and activities within a group. Within the wholly UK context, this is usually irrelevant given that distributions between UK resident companies will generally be tax-free under CTA 2009, Part 9A and transfers of assets between such companies will also be tax-free under TCGA 1992, s 171. CTA 2010, s 1085 provides, firstly, that if the distributing company is a 75 per cent subsidiary of a group, then the wider group (or groups) to which it belongs at the time of the distribution must itself be a trading group. Remember, also, that the requirement that the distributing company be a trading company or the holding company of a trading group is suspended, as noted above under CTA 2010, ss 1082(3) and 1084(1).

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24.48 Exempt distributions Most importantly, CTA 2010, s 1085 requires a series of further exempt distributions up the group until there is a distribution by a distributing company that is not a 75 per cent subsidiary of another company. In practice, the authors have never seen this requirement invoked for UK resident groups as there is invariably a preliminary reorganisation of the group such that the distributing company is the highest tier company in the group that is not a 75 per cent subsidiary of any other company. Where it is relevant, however, is in the context of the separation of a multinational group, as the highest tier UK resident company may be a 75 per cent subsidiary of another company that is not resident in an EU Member State. CTA 2010, s 1085(3) requires successive demergers until the ultimate parent company has made a distribution within CTA 2010, s 1076 or 1077. But if the ultimate holding company is not resident in an EU Member State, it will fail condition A in CTA 2010, s 1081(1) and, hence cannot satisfy the requirement of condition M in CTA 2010, s 1085(3), that it be an exempt distribution. Whether or not tax-free separation of the non-EU portions of the group is available in the appropriate jurisdictions would be irrelevant. CTA 2010, s 1085 requires that, where the distributing company is a 75 per cent subsidiary of another company, wherever resident, there be further exempt distributions to separate the rest of the group, not some other form of separation to which the exempt distribution provisions do not apply. The authors have seen this position once previously and the barrier posed by CTA 2010, s 1085 initially appeared to be insurmountable. However, the group management realised that the UK provisions were restrictive and that HMRC had no room to manoeuvre. As a result, the rest of the worldwide group was separated first. Therefore, by the time the UK demerger was performed, the ultimate UK group company was not in fact a 75 per cent subsidiary of either part of the now separated worldwide group. Some thought was given to whether structuring a worldwide demerger in this way was intended purely to bring the group within the UK legislative provisions for a tax-free demerger. However, a review of the overall worldwide strategy of the group demonstrated that the demerger was carried out for bona fide commercial reasons and HMRC took the view that the fact that the group had gone to great lengths to restructure its worldwide demerger to comply with UK tax legislation was acceptable tax planning rather than unacceptable tax avoidance – if they could structure their worldwide demerger in one of two ways, only one of which complied with the exempt distribution provisions, there was no reason to refuse clearance merely because they had chosen that route.

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Exempt distributions 24.51

Conclusions 24.49 These provisions are a very useful relief for EU resident trading companies and groups to be able to carry out demergers. Its usefulness is limited, however, by the very tightly drawn set of conditions over which HMRC has very little, if any, discretion. As a result, a number of genuinely commercial demergers have had to be restructured in different, usually more complex and more expensive ways, in order to achieve the desired commercial result.

CTA 2010, ss 1086 to 1090 – chargeable payments 24.50 As discussed in the overview above, the relief for exempt distributions was considered by HMRC to be a major ‘hole’ in the distributions legislation potentially open to abuse. As a result, we have a charge to income tax or to corporation tax on income in certain circumstances where ‘chargeable payments’ are made. As an opening comment, the authors would note that they have never seen this legislation invoked or a chargeable payment actually charged to tax. As an antiavoidance provision, it therefore appears to be doing its job very effectively.

The legislation CTA 2010, s 1086 – the basic charge 24.51 ‘(1) This section applies if a chargeable payment is made within 5 years after an exempt distribution. (2) The amount or value of the payment is chargeable– (a) to income tax, or (b) to corporation tax under the charge to corporation tax on income. (3) An amount charged to income tax under subsection (2) is treated for income tax purposes as an amount of income. (4) Income tax under subsection (2) is charged on the full amount or value of the payment made in the tax year. (5) The person liable for any income tax charged under subsection (2) is the person receiving or entitled to the payment.

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24.52 Exempt distributions (6) References in this section and sections 1087 to 1094 to a payment include– (a) the assumption of a liability, and (b) any other transfer of money’s worth.’ Analysis 24.52 This provision imposes an income or corporation tax charge where a ‘chargeable payment’ is made within five years of an exempt distribution. This includes any assumption of liability or transfer of value, and the tax charge is on the full amount of the payment (ie no deductions are allowed). CTA 2010, s 1087 – Chargeable payments not deductible in calculating profits 24.53 ‘If a chargeable payment is made within five years after an exempt distribution, the chargeable payment is treated as a distribution for the purposes of section 1305 of CTA 2009 (no deduction for distributions in calculation of a company’s profits).’ Analysis 24.54 From the perspective of the paying company, the payment is treated as a distribution, so that no deduction is permitted for corporation tax purposes. CTA 2010, s 1088 – the definition of ‘chargeable payment’ 24.55 ‘(1) In this Chapter “a chargeable payment” means any payment which– (a) meets each of conditions A to D in this section, or (b) is a chargeable payment by virtue of section 1089. (2) Condition A is that the payment is made by a company concerned in an exempt distribution and is made (directly or indirectly)– (a) to a member of that company, or (b) to a member of any other company concerned in the exempt distribution. (3) Condition B is that the payment is made– (a) in connection with the shares in the company making the payment,

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Exempt distributions 24.56 (b) in connection with the shares in any other company concerned in the exempt distribution, or (c)

in connection with any transaction affecting the shares mentioned in paragraph (a) or (b).

(4) Condition C is that the payment– (a) is not made for genuine commercial reasons, or (b) forms part of a tax avoidance scheme. (5) Condition D is that the payment– (a) is not a distribution or an exempt distribution, and (b) is not made to a company that belongs to the same group as the company making the payment. (6) In this section and section 1089–

“tax avoidance scheme” means a scheme or arrangement the main purpose or one of the main purposes of which is the avoidance of tax, and

“tax” includes stamp duty and stamp duty land tax.’

Analysis 24.56 A company concerned in an exempt distribution is defined at CTA 2010, s 1090 (see below). A member of a company is generally a person holding share capital of that company. However, for the purposes of CTA 2010, s 1088(2), CTA 2010, s 1099(1) also brings in a person who is a member of a company other than through holding the company’s share capital. This presumably refers to membership, for example, of companies without share capital, although it is likely to be rare for such companies to be concerned in an exempt distribution, so this provision is of limited application. In essence, a ‘chargeable payment’ is a payment made by a company concerned in an exempt distribution to a member of that company or a member of any other company concerned in that distribution. The payment must have been made in connection with, or with a transaction affecting, the shares of a company concerned in the exempt distribution. Distributions or other exempt distributions are not chargeable payments and nor are payments made to another company which belongs to the same group as the paying company. The thrust of the legislation, therefore, is clearly to catch payments to persons outside the group of the paying company that have somehow escaped treatment as distributions. 527

24.57 Exempt distributions There is, however, an overriding let-out for payments made for genuine commercial reasons and not forming part of a tax avoidance scheme. Pretransaction clearance is available under CTA 2010, s 1092 that a payment is not a chargeable payment for these reasons. In the authors’ experience, payments between companies after an exempt distribution are invariably for commercial reasons. Furthermore, such commercial payments are not connected with the shares of the company, so they clearly fall outside the intended scope of this legislation. CTA 2010, s 1089 – extension of the definition for unquoted companies 24.57 ‘(1) This section applies if a company concerned in an exempt distribution is an unquoted company and a person makes a payment (to any person) in pursuance of a scheme or arrangement made– (a) with the unquoted company, or (b) if the unquoted company– (i)

is under the control of 5 or fewer persons (its “main participators”), and

(ii) is not excepted by subsection (6), with any of the unquoted company’s main participators. (2) The payment is a chargeable payment if it meets each of conditions B1 to D1. (3) Condition B1 is that the payment is made– (a) in connection with the shares in the company (if it is a company) making the payment, (b) in connection with the shares in any company concerned in the exempt distribution, or (c)

in connection with any transaction affecting the shares mentioned in paragraph (a) or (b).

(4) Condition C1 is that the payment– (a) is not made for genuine commercial reasons, or (b) forms part of a tax avoidance scheme. (5) Condition D1 is that the payment (if made by a company)– (a) is not a distribution or an exempt distribution, and (b) is not made to a company that belongs to the same group as that company. 528

Exempt distributions 24.58 (6) The unquoted company subsection (1)(b)(ii) if–

is

excepted

for

the

purposes

of

(a) it is under the control of (and only of) a company, and (b) that company is not under the control of 5 or fewer persons.’ Analysis 24.58 This is an extension of the meaning of a chargeable payment where unquoted companies are involved. The starting point is that there must be an unquoted company that is concerned in an exempt distribution (as defined at CTA 2010, s 1090, below), there must be an arrangement with that company and a person must make a payment to any other person in pursuance of that arrangement. Also, if the unquoted company is under the control of five or fewer participators (broadly, a close company as defined by CTA 2010, s 439), an arrangement with any of those five or fewer participators is also caught (this last provision does not apply if the company is under the control of another company that is, itself, not close). This is clearly a very broad definition and is likely to be in point in respect of the vast majority of private company demergers. A payment is then a chargeable payment only if it satisfies the three conditions, B1, C1 and D1. Condition B1 is that the payment is made in connection with the shares in the company making the payment, with the shares of any other company concerned in the exempt distribution or in connection with any transaction affecting the shares of the company making the payment or of any other company concerned in the exempt distribution. Once again, this is a very widely drawn piece of legislation, including vague but wide ranging terms such as ‘in connection with’ and ‘affecting’. Condition C1 is the overriding let-out for payments made for genuine commercial reasons and not forming part of a tax avoidance scheme. Condition D1 excepts distributions or other exempt distributions payments made to another company which belongs to the same group as the paying company from being chargeable payments. We assume that extension of the scope of the anti-avoidance provision is to prevent abuse in cases where the companies concerned in an exempt distribution have the much wider fiscal latitude afforded to private companies and those under the control of five or fewer persons. The very wide scope of CTA 2010, s 1089, however, means that parties entirely unconnected with the transaction are occasionally caught. In general, the best way not to get caught

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24.59 Exempt distributions by this provision is to be able to demonstrate the commercial bona fides of the proposed transaction. CTA 2010, s 1099 tells us that ‘control’ is to be construed in accordance with CTA 2010, ss 450 and 451. The definition of an unquoted company is at CTA 2010, s 1098 (immediately following). CTA 2010, s 1098 – meaning of ‘unquoted company’ 24.59 ‘(1) A company is an unquoted company for the purposes of this Chapter if none of its shares is– (a) listed in the Official List of the Stock Exchange, and (b) dealt in on the Stock Exchange regularly or from time to time. (2) But a company is not an unquoted company for the purposes of this Chapter if it is under the control of (and only of) one or more companies which are not unquoted companies for those purposes. (3) The reference in subsection (1) to shares does not include debenture stock, loan stock, preferred shares or preferred stock.’ Analysis 24.60 CTA 2010, s 1098 tells us that unquoted companies are those that do not have any of their shares listed on the London Stock Exchange. Loan stock, debenture stock, preferred shares and preferred stock are ignored for this purpose, and the definition does not apply to a company that is under the control of a quoted company. Given that this definition refers only to the London Stock Exchange, it is probable that this definition is discriminatory under EU law, as forming a barrier to demergers or to post-demerger payments for companies listed on other European Stock Exchanges. Whether this matters, now that the UK has formally left the EU, remains to be seen. CTA 2010, s 1090 – meaning of ‘a company concerned in an exempt distribution’ 24.61 ‘(1) For the purposes of this Chapter the companies concerned in an exempt distribution are– (a) any relevant company (as defined in section 1080), and

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Exempt distributions 24.63 (b) any other company which was connected with any relevant company for the whole or any part of the affected period. (2) In this section “the affected period” means the period– (a) beginning with the exempt distribution, and (b) ending with the making of the payment in question. (3) For the purposes of this section, if a company (“A”) is connected with another company (“B”) in the affected period, A is also connected in that period with any company with which B is connected (with or without the help of this subsection) in that period. Analysis 24.62 A company concerned in an exempt distribution includes any relevant company: that is, the distributing company, the company whose shares are distributed or the transferee company – see CTA 2010, s 1080 – or any company connected with a relevant company at any time from the date of the exempt distribution to the date the chargeable payment is made. CTA 2010, s 1176(1) applies the meaning of ‘connected’ in CTA 2010, s 1122 for the purposes of the exempt distributions legislation. However, the definition of connection is extended for the purposes of the chargeable payments legislation by CTA 2010, s 1090(3). For example, if company A is connected with company B and company B is connected with company C, then company A will be connected with company C, even if CTA 2010, s 1122 would not have made company A connected with company C. Somewhat bizarrely, it also seems that if companies A and B are connected and the connection ceases and company B becomes connected to company C within the period mentioned above, then company A is connected with company C in that period.

Practical advice regarding chargeable payments 24.63 HMRC’s Press Release of 20 June 1980 gives an example of when the anti-avoidance provisions would be used. HMRC proposes a situation where a company demerges shares in a subsidiary to its members and within five years the transferee company buys back those shares from the shareholders. The result would be to pass cash to the shareholders and this would be caught by the legislation. However, a genuine sale by the shareholders to a third party would not be caught (although if the onward sale of the shares was part of the overall scheme of demerger, CTA 2010, s 1081(5)(a) would operate, in any case, to deny the exemption).

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24.64 Exempt distributions On a practical level, the authors have always considered the chargeable payments rules to be very widely drawn, particularly where unquoted and close companies are concerned. For example, notwithstanding HMRC’s comments in the Press Release, an onward sale after an exempt distribution is technically caught by the words of the legislation, as the third party purchaser would be ‘any other person’ making a payment to a member of a company concerned in an exempt distribution. So the main escape in this context will be through the genuine commercial reason let out. In circumstances such as these, the authors would almost always recommend making a clearance application under CTA 2010, s 1092 to avoid unpleasant surprises (see below). Furthermore, if a company becomes connected with another company that has made an exempt distribution within the previous five years, great care should be taken as regards transactions between either of these companies and their shareholders. Suitably worded indemnities should be included as standard clauses in share purchase agreements. However, in this situation, clearance under CTA 2010, s 1092(4) should also be considered as an option (see below). CTA 2010, ss 1091 and 1092 – pre-transaction clearances 24.64 These provisions contain the clearance procedure that allows a demerging company or group to seek certainty from the Board of HMRC, via the BAI Clearance Team, that the transactions proposed meet the criteria to be exempt distributions, or that they are not chargeable payments. They cover the clearances that might be obtained, the mechanism for applying for and processing applications and the consequences of incomplete disclosure.

The legislation CTA 2010, s 1091 – advance clearance of distributions 24.65 ‘(1) Before a distribution is made, the distributing company may apply under this section to the Commissioners for Her Majesty’s Revenue and Customs (“the Commissioners”). (2) If, before the distribution is made, the Commissioners notify that company that they are satisfied that it will be an exempt distribution, the distribution is treated as an exempt distribution.’ The most important and frequently used clearance is the first, being a pretransaction clearance that a demerger will be an exempt distribution. The clearance application here is to be made by the distributing company. 532

Exempt distributions 24.66 One important distinction between this clearance and other similar clearances – such as capital gains clearances under TCGA 1992, ss 138 and 139 – is that HMRC gives certainty that the transaction will be an exempt distribution, as all the conditions of CTA 2010, ss 1081–1085 are satisfied. In contrast, the capital gains clearances only give certainty that HMRC is satisfied that the transactions are carried out for bona fide commercial reasons and will not form part of any scheme or arrangements the main purpose, or one of the main purposes, of which is the avoidance of tax. Those clearances do not give any certainty that the other conditions for relief are satisfied, whereas the clearance under CTA 2010, s 1091 does precisely that for all the detailed conditions of CTA 2010, ss 1081–1085. Interestingly, CTA 2010, s 1091 does not allow for a clearance to be given once a transaction has been completed, as it refers only to ‘before the distribution is made’. It is therefore imperative that, where clearance is desired, early action is taken to avoid potential delays. CTA 2010, s 1092 – advance clearance of payments 24.66 ‘(1) If– (a) a person intending to make a payment applies under this section to the Commissioners, and (b) before the payment is made the Commissioners notify the person that they are satisfied that the payment meets the conditions set out in subsection (2), the payment is not treated as a chargeable payment. (2) The conditions are that the payment– (a) will be made for genuine commercial reasons, and (b) will not form part of a scheme or arrangement the main purpose or one of the main purposes of which is the avoidance of tax. (3) In subsection (2) “tax” includes stamp duty and stamp duty land tax. (4) A company which– (a) becomes connected with another company, or (b) ceases to be connected with another company,

may make an application under subsection (1) with respect to any payments that may be made by it at any time after becoming or ceasing to be connected with the company in question (whether or not there is any present intention to make any payments).

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24.67 Exempt distributions (5) If the Commissioners give a notification on an application made by virtue of subsection (4), no payment to which the notification relates is to be treated as a chargeable payment merely because the company is or has been connected with the other company.’ Analysis 24.67 CTA 2010, s 1092(1) and (2), the clearance for chargeable payments, is a straightforward clearance that the payment is made for bona fide commercial reasons and will not form part of any scheme or arrangements the main purpose, or one of the main purposes, of which is the avoidance of tax. There is therefore no technical sign off as to whether the payment would otherwise be a chargeable payment, for example. But then there is no need for such a sign-off as, assuming clearance is granted, it just doesn’t matter. This application is to be made by the person intending to make the chargeable payment, although this requirement is not always adhered to and HMRC has accepted applications from the company whose members are affected, for example, where that was appropriate. However, once again, the application is to be made before the payment is made, as the Commissioners of HMRC must notify their satisfaction before the payment is made. A scenario that is becoming more common is that there may be continued commercial links between the companies or groups after a demerger, which are identified beforehand. Examples range from simple situations, such as continuing to share occupancy of premises, such that one company has to pay rent to the other, to more complex situations. In such cases, we recommend that the clearance application under CTA 2010, s 1092 be incorporated into the general demerger clearance application. Since the chargeable payments legislation applies to all companies concerned in an exempt distribution, which includes the ‘relevant companies’ (CTA 2010, s 1080) and any companies connected to them (CTA 2010, s 1090), CTA 2010, s 1092(4) is a useful further clearance where companies become or cease to be connected with a relevant company, such as when a new company is acquired by a group or when a group company is sold to a third party. In essence, a company joining a group can apply for clearance that, not having been ‘a company concerned in an exempt distribution’ at the time of that distribution, any payments it might make will not be chargeable payments. Similarly, a company leaving a group can apply for clearance that, now that it is no longer ‘a company concerned in an exempt distribution’, any payments it might make will not be chargeable payments. Technically, applications to which CTA 2010, s 1092(4) relate are made under CTA 2010, s 1092(1), so they are clearances as to the commercial bona fides of the payments. 534

Exempt distributions 24.70 Clearances under CTA 2010, s 1092(4) are relatively uncommon in the authors’ experience, but should possibly be used more often. In addition, the authors have seen it used where a relevant company has been sold to a third party. Although not strictly within the terms of the legislation, as there are no provisions whereby a company might cease to be a relevant company, HMRC has given clearance that the chargeable payments legislation need not be considered further in respect of the company sold. CTA 2010, s 1093 – requirements relating to applications for clearance 24.68 ‘(1) Any application under section 1091 or 1092– (a) must be in writing, and (b) must contain particulars of the relevant transactions. (2) The Commissioners may by notice require a person making an application under section 1091 or 1092 to provide further particulars for the purpose of enabling them to make their decision. (3) The power under subsection (2) must be exercised within 30 days of the receipt of– (a) the application, or (b) any further particulars previously required under subsection (2). (4) If a notice under subsection (2) is not complied with within 30 days, or any longer period that the Commissioners may allow, the Commissioners need not proceed further on the application.’ Analysis 24.69 Most of this mechanical legislation is self-explanatory: the clearance application must be in writing – to BAI Clearance, not to the local inspector – and HMRC may ask for further information within 30 days. If the information is not supplied within 30 days (unless a longer period is allowed), the application lapses. CTA 2010, s 1094 – decision of the Commissioners or tribunal 24.70 ‘(1) The Commissioners must notify their decision to the person making the application under section 1091 or 1092– (a) within 30 days of receiving the application, or (b) if they give a notice under section 1093(2), within 30 days of when the notice is complied with. 535

24.71 Exempt distributions (2) Subsection (3) applies if the Commissioners– (a) (in the case of an application under section 1091) notify the applicant that they are not satisfied that the distribution will be an exempt distribution, (b) (in the case of an application under section 1092) notify the applicant that they are not satisfied that a payment meets the conditions set out in section 1092(2), or (c)

(in either case) do not notify their decision to the applicant within the time required by subsection (1).

(3) The applicant may require the Commissioners to transmit the application, together with any notice given and further particulars provided under section 1093(2), to the tribunal. (4) In that event, any notification by the tribunal has effect for the purposes of this section as if it were a decision of the Commissioners. (5) The right under subsection (3) must be exercised within 30 days of– (a) the notification of the Commissioners’ decision, or (b) the time by which the Commissioners are required to notify their decision to the applicant. (6) If any particulars provided under section 1093 in relation to an application under section 1091 do not fully and accurately disclose all facts and circumstances material for the decision of the Commissioners or tribunal, any resulting notification that the Commissioners are satisfied, or that the tribunal is satisfied, that the distribution will be an exempt distribution is void. (7) If any particulars provided under section 1093 in relation to an application under section 1092 do not fully and accurately disclose all facts and circumstances material for the decision of the Commissioners or tribunal, any resulting notification that the Commissioners are satisfied, or that the tribunal is satisfied, that the payment in question meets the conditions set out in section 1092(2) is void.’ Analysis 24.71 Again, much of this is self-explanatory: HMRC must notify the applicant of their decision within 30 days of receiving the application or of receiving the information previously requested. Should the Commissioners fail to comply with the time limits or refuse to grant a clearance, the applicant may appeal to the First-tier Tribunal by requiring HMRC to transmit the correspondence to the Tribunal. The time limit for 536

Exempt distributions 24.71 the appeal is 30 days from the expiry of the original (or subsequent) 30-day time limit or, in the case of a refusal, 30 days from the date of the refusal. A decision by the First-tier Tribunal is treated as if it were a notification by the Commissioners of HMRC. More importantly, the First-tier Tribunal’s decision is final and a clearance by the First-tier Tribunal therefore overrides HMRC’s refusal. For more detail on the process of getting a clearance, see Chapter 14. Not surprisingly, should an application be found not to have fully disclosed all the relevant facts, the clearance can be voided. While this is a particularly frightening piece of legislation, a post-transactional voiding of the relief under CTA 2010, s 1094(6) or (7) has never been invoked in the authors’ experience. Arguably, this is another example of anti-avoidance legislation doing its job. What is a material fact or circumstance is a matter to be considered on a case by case basis. The authors believe that the best approach is to assume that everything that appears material or even possibly material should be disclosed. This is so even if the matter to be disclosed might be such as apparently to jeopardise the ability to obtain a clearance (examples seen by the authors are unsolicited offers for the business that are under consideration, although the demerger is intended for other, completely commercial, reasons). This is vital because it is always going to be easier to restructure a transaction or change one’s mind before anything irrevocable has been done. If a transaction has been carried out and HMRC subsequently voids a clearance as a result of some further information, the tax consequences of the demerger must follow as the demerger cannot be retroactively ‘undone’. Another important practical issue is that it is the facts at the time of the demerger that are important, not the facts at the time of the application for clearance or at the time the clearance is granted. So if there is a material change in the fact pattern before the demerger is carried out, it is imperative that this be disclosed. Otherwise, there is a risk that a demerger is carried out on the mistaken belief that a clearance is in place when there has been a material change of circumstances and the clearance given cannot be guaranteed to remain valid. One situation where CTA 2010, s 1094(6) is often considered is the postdemerger sale of a relevant company. The authors have seen a number of cases where an offer has been made to buy a company that has previously been either the distributing or transferee company of an exempt distribution. If such a company is sold within five years of the demerger and the company is unquoted, the rules might apply to deem the disposal proceeds to be a chargeable payment, so clearance under CTA 2010, s 1092 should be considered (bearing in mind that the application should strictly be made by the payer, the purchaser,

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24.72 Exempt distributions although this is one of the situations where, in the authors’ experience, HMRC will accept an application from the company itself). However, particularly if the proposed disposal is only shortly after the demerger, HMRC is also likely to question whether the disposal was contemplated at the time of the demerger and, therefore, whether a material fact was omitted from the application, such that the clearance should be rescinded. It is, therefore, important to be able to demonstrate when the offer was made and that it was not being mooted at the time of the demerger (accepting also the difficulty inherent in proving a negative).

Practical issues relating to clearances 24.72 HMRC’s Statement of Practice 13/1980 is extremely helpful in detailing the main areas of information that should be given in any clearance application. As a practical point, it is vital that the initial clearance application is complete in all material respects in order to avoid HMRC asking for further information, thus restarting the 30-day clock. Equally important is clarity in the clearance application; in the authors’ experience, the best letters are those that tell the story clearly, concisely and logically, so the inspector has all the information required to grant a clearance without further ado. A badly written letter invites queries and therefore creates delay. Given the timing built into CTA 2010, ss 1093 and 1094, it is also important to consider clearance applications earlier rather than later. This is mainly to ensure that there is plenty of time to obtain clearance for a transaction before the transaction is carried out, bearing in mind the 30-day time limit and the possibility of more than one round of correspondence, but it is also important because it is not possible to rely on HMRC being willing to expedite a clearance for an imminent transaction, particularly at busy times when there are other clearance applications that may be getting close to the 30-day deadline. So far as the inspector is concerned, your clearance is no more and no less important than anybody else’s and there is nothing more annoying than being begged for an urgent clearance when it is clear that the transaction had been under consideration for some considerable time and the clearance application could and should have been made much earlier in the process. While clearance applications should be comprehensive, it is frequently the case that the final details are not decided until relatively late in the process. In such a case, it is preferable, in the authors’ experience, to make a clearance application earlier rather than later, also making a point of detailing the area(s) where decisions are yet to be finalised, together with the likely outcome. If the 538

Exempt distributions 24.73 final decisions are materially different from what was originally advised to HMRC, a supplementary letter will be required to get final sign off. Strictly, such a letter is a new application for clearance, but, in circumstances like this, the inspector will usually expedite the clearance on the basis that there are only minor differences to consider. If a clearance is granted, clearly, the transaction can proceed. If clearance is refused, however, all is not lost! First, although the legislation does not require HMRC to explain why the clearance has been denied, as a matter of practice, an applicant is always informed as to the area(s) of concern. Similarly, while there is no legal provision permitting correspondence with HMRC once clearance has been denied, in practice, HMRC is generally willing to consider further comment or to opine on changes to the structure, with a view to being able to grant clearance. Remember, however, as always, that HMRC’s latitude is limited and also that their ability to respond swiftly is likely to depend upon how busy the inspectors are. If all else fails, there is still transmission to the First-tier Tribunal to consider. HMRC is quick to point out that transmission to the Tribunal is not, technically, an appeal. However, that is its practical impact, in that dissatisfied taxpayers can require the decision of HMRC to be reconsidered and possibly remade by a Tribunal judge. Readers may be a little circumspect about an appeal to the First-tier Tribunal. However, this is a very simple and straightforward process and, important to many taxpayers and practitioners, the process does not require a personal hearing in front of the Tribunal, it is all done by correspondence. The legislation says that HMRC must ‘transmit’ the application letter and other information to the Tribunal, which will then consider it and make a decision. In practice, the applicant will usually accompany the request for review by the First-tier Tribunal with a detailed explanation as to why the applicant considers HMRC’s refusal to be incorrect. The inspector will then forward this, with all the other correspondence, to the Clerk to the First-tier Tribunal, with a detailed exposition of HMRC’s reasons for refusal. In the authors’ experience, this is also copied to the applicant. The First-tier Tribunal’s decision usually comes through in three to five weeks or so and is sent to both HMRC and the applicant. Overall, this is not a daunting process and its use should be considered more often in borderline cases.

Conditions attached to clearances 24.73 We referred earlier to HMRC imposing conditions on clearances under certain circumstances (specifically, we referred to the Millennium Chemicals situation on demerger from Hanson plc). There are those who have questioned

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24.73 Exempt distributions HMRC’s right to insist upon such onerous conditions or indeed to insist on any conditions at all on giving a clearance. Technically, it is indeed clear that CTA 2010, ss 1091 and 1092 do not per se permit the imposition of conditions on a clearance. However, as one of the authors of this book has worked as part of an HMRC unit responsible for granting clearances, we can offer the opinion that HMRC is not acting ultra vires in imposing conditions on occasion, but is, instead, acting wholly lawfully according to its obligations and responsibilities for care and management of the UK’s direct tax system. Indeed, there is a case for saying that HMRC is acting in the best interests of the relevant companies too. When we refer to imposition of conditions, we are not referring to the situation where HMRC is satisfied that it would not grant clearance unless the transaction were restructured in order to remove any part that HMRC found offensive. In such cases, it is clear that HMRC is permitted – indeed obliged – to refuse clearance where it considers that the detailed conditions of the exempt demerger legislation are not satisfied. Far from imposing conditions on a clearance, what HMRC is actually doing is explaining to the applicant why the clearance is being denied. This then gives the applicant the opportunity to restructure the transaction in a way that HMRC does not find offensive and hence get the clearance they require. This type of correspondence has, on occasion, been carried out informally in order to expedite the granting of a clearance. Without that level of informality, the time scale for clearance would be extended as the applicant would have to reapply for clearance with the restructured transaction and the 30-day clock would start again. When we talk about imposing conditions, we are looking specifically at cases where HMRC has insisted that a company acts or operates in a particular way for a period of time after the demerger. This only occurs where HMRC accepts that the conditions are satisfied for the legislation to apply, but that compliance with those conditions is potentially ephemeral and the parties may intend to unwind them as soon as possible thereafter. If the parties undertake that there is no such intention, HMRC takes the view that it is entitled to accept that as a condition in relation to the demerger. In essence, the confirmation that the condition is intended to be satisfied for the foreseeable future is part of the information given to HMRC as part of the clearance application. If that information turns out to be incorrect, HMRC would have the right (or, again, obligation) to review the original clearance under CTA 2010, s 1094(6) or (7), but this would mean a great deal of administrative difficulty and tax risk for the parties to the demerger. Far better for them that a specific condition be imposed by agreement between them and HMRC in advance of the transactions taking place. None of this precludes the possibility that a change in commercial circumstances will necessitate a change of view on the specific issue. If this were to happen, 540

Exempt distributions 24.76 a further informal application that the condition be lifted could be made. This is essentially no different from the situation referred to above relating to the post-demerger sale of a relevant company. It is important to emphasise, however, that this is an extremely rare scenario. In many years of dealing with clearances, from both sides of the fence, we have only seen a requirement for conditions on two or three occasions.

CTA 2010, ss 1095 and 1096 – returns 24.74 The demerger legislation has its own specific return requirements in CTA 2010, ss 1095 and 1096, for exempt distributions and chargeable payments, respectively. This covers returns of both exempt distributions and of chargeable payments.

CTA 2010, s 1095 – exempt distributions: returns 24.75 ‘(1) A company which makes an exempt distribution must make a return to an officer of Revenue and Customs. (2) The return must give details of– (a) the distribution, and (b) the circumstances by reason of which it is exempt. (3) The return must be made within 30 days after the distribution.’ Analysis 24.76 CTA 2010, s 1095 states that where a company makes an exempt distribution, it must make a return to HMRC giving particulars of the distribution and why the company considers the distribution to be exempt. Generally, though, a letter with the clearance reference on it, confirming that the transaction proceeded as described in the clearance application, is sufficient. The time limit for making such a return is 30 days from the making of the exempt distribution. Occasionally, a letter granting clearance from HMRC for an exempt distribution will give the address to which the return should be sent1, although this is somewhat hit-and-miss in the authors’ experience. On one memorable occasion, one of the authors even received an acknowledgment of the return! Otherwise, we send the return to the tax office that deals with the affairs of the distributing company. For additional certainty, we also email 541

24.77 Exempt distributions a copy to BAI Clearance, as there is not an email alternative to posting the actual return.

1 In August 2018 it was HM Revenue and Customs, CT Services, BX9 1AX.

CTA 2010, s 1096 – chargeable payments etc: returns 24.77 ‘(1) A person must make a return to an officer of Revenue and Customs if– (a) the person makes a chargeable payment within five years after the making of an exempt distribution, and (b) the chargeable payment consists of a transfer of money’s worth. (2) The return under subsection (1) must give details of– (a) the transaction effecting the transfer, (b) the name and address of each recipient, (c)

the value of what is transferred to each recipient, and

(d) any payment of money which accompanies the transfer and is itself a chargeable payment. (3) A person must make a return to an officer of Revenue and Customs if, within five years after the making of an exempt distribution, the person makes a payment or transfer of money’s worth which– (a) is made for genuine commercial reasons and does not form part of a scheme or arrangement the main purpose or one of the main purposes of which is the avoidance of tax, but (b) would be a chargeable payment if that were not so. (4) In subsection (3)(a) “tax” includes stamp duty and stamp duty land tax. (5) Subsection (3) does not apply if a notification under section 1092(5) (payment not to be treated as a chargeable payment merely because of a connection between two companies) has effect in relation to the payment or transfer. (6) In the case of a transfer, the return under subsection (3) must give the following information– (a) details of the transaction which effects the transfer, (b) the name and address of each recipient, (c)

the value of what is transferred to each recipient, and 542

Exempt distributions 24.78 (d) a statement of the circumstances by reason of which the transfer is not a chargeable payment. (7) In the case of a payment, the return under subsection (3) must give the following information– (a) the name and address of each recipient, (b) the amount of the payment made to each recipient, and (c)

a statement of the circumstances by reason of which the payment is not a chargeable payment.

(8) The return under subsection (1) or (3) must be made within 30 days after the transfer or payment.’ Analysis 24.78 CTA 2010, s 1096(1) requires a return to be made where a person makes a chargeable payment which consists of a transfer of money’s worth within five years from making an exempt distribution. The information required, which is listed at CTA 2010, s 1096(2), includes details of any chargeable payment in cash that accompanies the chargeable payment in money’s worth. CTA 2010, s 1096(3) requires a return to be made where, within five years from making an exempt distribution, a person makes a payment or a transfer of money’s worth which would be a chargeable payment but for being a payment or transfer for genuine commercial reasons and not for the avoidance of tax. CTA 2010, s 1096(6) and (7) specify the information required for a payment or a transfer of value, respectively. This legislation seems to have an odd lacuna, as there is no requirement to make a return of a chargeable payment that is only in cash, that is not for genuine commercial reasons or is part of a scheme for the avoidance of tax. However, this is unlikely to be of any practical relevance. The information required, which is listed at CTA 2010, s 1096(2), includes details of any chargeable payment in money that accompanies the chargeable payment by way of a transfer of money’s worth. Returns must be made within 30 days from the making of the payment or transfer. CTA 2010, s 1096(5) tells us that such a return under CTA 2010, s 1096(3) is not required where a company has received a clearance under CTA 2010, s 1092(5), as detailed above.

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24.79 Exempt distributions

CTA 2010, s 1097 – information about person for whom a payment is received 24.79 ‘(1) An officer of Revenue and Customs may require any recipient of a chargeable payment to state– (a) whether it is received by the recipient on behalf of another person, and (b) if so, that person’s name and address. (2) An officer of Revenue and Customs may require a person (“A”) on whose behalf a chargeable payment is received to state– (a) whether there is another person (in addition to A) on whose behalf the payment is received, and (b) if so, that person’s name and address.’ Analysis 24.80 This provision compels any recipient of a chargeable payment (or any person on whose behalf such a payment is received), if required by HMRC, to confirm whether the payment received is received on behalf of any other person and, if so, the name and address of that person. Similarly, HMRC can request information from the person on whose behalf a payment is received in respect of other such persons.

General information powers 24.81 There are no longer specific information powers for the general purposes of the demergers legislation, apart from the provisions already discussed, above. Instead, HMRC can use the wide-ranging general information powers in FA 2008, Sch 36.

CTA 2010, s 1099 – interpretation 24.82 Whilst the terminology used in the statutory demergers code is generally consistent with the Taxes Acts, this section defines some words and expressions in the context of the legislation. The legislation is not reproduced or discussed here, but the relevant definitions are discussed, as appropriate, throughout this chapter.

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Exempt distributions 24.87

TCGA 1992, s 192 – additional provisions relating to exempt distributions 24.83 TCGA 1992, s 192 contains some important provisions relating to exempt distributions and their interactions with the capital gains legislation.

The legislation TCGA 1992, s 192(1) – introduction 24.84 ‘(1) This section has effect for facilitating certain transactions whereby trading activities carried on by a single company or group are divided so as to be carried on by two or more companies not belonging to the same group or by two or more independent groups.’ Analysis 24.85 This is purely introductory, although it is interesting to note that it is couched in exactly the same terms as CTA 2010, s 1074. The earlier comments relevant to CTA 2010, s 1074 are equally relevant here. TCGA 1992, s 192(2) – provisions relevant to direct demergers (CTA 2010, s 1076) 24.86 ‘(2) Where a company makes an exempt distribution which falls within section 1076 of CTA 2010 – (a) the distribution shall not be a capital distribution for the purposes of section 122; and (b) sections 126 to 130 shall, with the necessary modifications, apply as if that company and the subsidiary whose shares are transferred were the same company and the distribution were a reorganisation of its share capital.’ Analysis 24.87 TCGA 1992, s 192(2) relates only to direct demergers under CTA 2010, s 1076. First, it provides that an exempt distribution is not a capital distribution under TCGA 1992, s 122. TCGA 1992, s 122 provides that a capital distribution is

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24.88 Exempt distributions any distribution in money or money’s worth that is not income in the hands of the recipient (TCGA 1992, s 122(5)(b)) and that capital distributions are to be treated as part disposals of the shares in respect of which the distribution is made. Therefore, in the absence of this provision, the recipient of shares in a direct demerger would be treated as having made a part disposal of the shares of the distributing company with appropriate tax consequences. That said, as noted in the discussion under CTA 2010, s 1075, above, since exempt distributions are not distributions for any purposes of the Corporation Tax Acts, which includes TCGA 1992, there is an argument that TCGA 1992, s 122 cannot apply here, anyway, and that TCGA 1992, s 192(2)(a) is otiose. This provision also treats the demerger as a reorganisation of the share capital of the distributing company with any ‘necessary modifications’. This means that a shareholder receiving shares in the demerged company, as well as holding the shares in the distributing company, will be treated as if both sets of shares were acquired at the same time and for the same total price. Similarly, if only one shareholder gets shares in the demerged company and relinquishes the holding in the distributing company, the shares acquired will be treated as if they were acquired at the same time and for the same price as the original shares. Where the shareholder is a trading company, however, there is a different analysis as the substantial shareholding exemption would probably come into play. If this is the case, TCGA 1992, Sch 7AC, para 4(3) disapplies both the reorganisation provisions and TCGA 1992, s 192(2)(a) from the demerger. The effect is that a corporate shareholder is treated as receiving a capital distribution under TCGA 1992, s 122, so that there is a deemed part disposal of the shares in the distributing company. This will, of course, not be a chargeable gain as the substantial shareholding exemption applies, but it will give the shareholder market value base cost in the shares of the demerged company and reduce the base cost in the shares of the distributing company (by the part disposal formula, A/(A+B)). These will only be relevant if there is a subsequent disposal to which the substantial shareholding exemption does not apply, however. TCGA 1992, s 192(3) and (4) – provisions relating to the degrouping charge (TCGA 1992, s 179) 24.88 ‘(3) Subject to subsection (4) below, section 179 shall not apply in a case where a company ceases to be a member of a group by reason only of an exempt distribution. (4) Subsection (3) above does not apply if within 5 years after the making of an exempt distribution there is a chargeable payment; and the time for making an assessment under section 179 by virtue of this subsection shall not expire before the end of 3 years after the making of the chargeable payment.’ 546

Exempt distributions 24.91 Analysis 24.89 TCGA 1992, s 192(3) gives relief from the TCGA 1992, s 179 degrouping charge that would otherwise apply in respect of assets transferred into a company from another group company in the six years prior to a demerger. Where the only reason a company leaves a group is by virtue of an exempt distribution, TCGA 1992, s 179 does not apply. This relief is crucial in allowing groups to be reorganised in order that the right activities can be demerged without having to be concerned about TCGA 1992, s 179. In other types of demerger, there is no such exemption and, as we have seen, this makes other demerger structures much harder to carry out tax efficiently. TCGA 1992, s 192(4), however, removes that relief where a chargeable payment is made within five years from the making of the exempt distribution. The exit charged is then reinstated and HMRC has three years to assess the charge. TCGA 1992, s 192(5) and (6) – definitions 24.90 ‘(5) In this section –

“chargeable payment” has the meaning given in section 1088 of CTA 2010;

“exempt distribution” means a distribution which is exempt by virtue of sections 1076 or 1077 of CTA 2010; and

“group” means a company which has one or more subsidiaries together with that or those subsidiaries.

(6) In determining for the purposes of this section whether one company is a 75% subsidiary of another, the other company shall be treated as not being the owner of – (a) any share capital which it owns directly in a body corporate if a profit on a sale of the shares would be treated as a trading receipt of its trade; or (b) any share capital which it owns indirectly in a body corporate and which is owned directly by a body corporate for which the sale of the shares would be a trading receipt.’ Analysis 24.91 The remainder of the section is concerned with definitions and in particular is a link to the definitions of exempt distributions and chargeable payments. It is noteworthy, however, that the exemption from the degrouping

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24.92 Exempt distributions charge, in particular, does not apply where the exempt distribution is under CTA 2010, s 1078, a cross-border demerger. It also defines a ‘group’ as ‘a company which has one or more 75 per cent subsidiaries together with that or those subsidiaries’ and in determining whether one company is a 75 per cent subsidiary of another, any shares held as trading stock are ignored. This is the same definition as is used in CTA 2010, s 1099 for the purposes of the exempt distributions legislation (except for CTA 2010, s 1081(5)(d)).

EXAMPLES AND ANALYSES 24.92 To draw all the information together, we are now going to run through a number of examples of demergers in order to demonstrate whether and how the various capital gains reliefs might apply. In all cases, we assume that all the appropriate conditions are satisfied and that the transactions are therefore not distributions for any purposes.

Direct demergers 24.93 In a direct demerger (see Figure 24.6(a) and (b)) the shares of the subsidiary are distributed to the shareholder(s) directly, so the shareholders of the distributing company are also the shareholders of the transferred company. Figure 24.6 Direct demergers – CTA 2010, s 1076

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Exempt distributions 24.94

In Figure 24.6(b), the intention is to segregate the shareholdings, so that one shareholder retains shares in the distributing company and the other only has shares in the transferred company. This would be achieved by, first, reorganising the shares of the distributing company into A and B shares. The A shares will only have rights over the parent company and the B shares will only have rights over the subsidiary. The distribution will then be made to the B shareholder only and, once the distribution has been made, his B shares in the distributing company will be worthless and, typically, they would be cancelled or sold to the A shareholder for a nominal consideration.

Relief for distributing company 24.94 The most important thing about the direct demerger is that there is no issue of shares by any company. Clearly, therefore, the transaction cannot be a scheme of reconstruction as the first condition of TCGA 1992, Sch 5AA requires an issue of shares. So direct demergers are not schemes of reconstruction. As a result, there is no relief from corporation tax on chargeable gain for the distributing company. As mentioned earlier in this chapter, before the substantial shareholding exemption (TCGA 1992, Sch 7AC) was introduced in FA 2002, these types of demerger were virtually never seen in practice. However, since 2002, it is likely that any demerger that satisfies the trading conditions of CTA 2010, s 1081(2) will also almost certainly satisfy the trading company conditions of the substantial shareholding exemption. Therefore, we would assume in a transaction like this that the substantial shareholding exemption would apply and the disposal would be exempt from corporation tax on chargeable gain.

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24.95 Exempt distributions

Reliefs for non-corporate shareholders 24.95 In contrast to the corporate level, at shareholder level, there are a number of applicable reliefs. First, CTA 2010, s 1075(1) states that the transaction is not a distribution. Although this is only for the purposes of the Corporation Tax Acts, once a transaction is not a distribution from a company’s perspective, it is hard to see how it can be an income distribution charged to income tax under ITTOIA 2005, s 382. As discussed above, absent any further relief, a distribution that is not an income distribution must be a capital distribution, by TCGA 1992, s 122, as if it were a disposal or part disposal of the shareholding. However, by TCGA 1992, s 192(2)(a), the distribution is also deemed not to be a capital distribution. Finally, therefore, we look at TCGA 1992, s 192(2)(b) which tells us that the transaction is to be treated as a reorganisation of the share capital of the distributing company. This has been covered in detail above, but the broad result in the first example (Figure 24.6(a)) is that the shareholders end up with shares in both the demerged company and the distributing company and those shares are treated as if both sets of shares were acquired at the same time and for the same total price as the original shares held in the distributing company. The allocation of base cost, in respect of later disposals, is dealt with in TCGA 1992, ss 129 and 130. In Figure 24.6(b), the first step, reorganising the share capital into A and B shares, is a reorganisation to which TCGA 1992, s 127 applies. So there is no disposal and each shareholder has the same base cost in their A or B shares as they had in the original ordinary shares they acquired. For the A shareholder, who merely retains the shareholding in the distributing company, that is the end of the matter. That shareholder requires no relief as there is no disposal on the demerger. For the B shareholder, who has shares in the subsidiary after the distribution, the original base cost of his shares is theoretically split between the B shares of the distributing company and the shares of the company that has been transferred. However, in practice, the B shares of the distributing company are worthless, so the practical result is that that shareholder now has the same base cost in the shares of the ex-subsidiary as in the original holding in the distributing company.

Reliefs for corporate shareholders 24.96 As with liquidation demergers, we have to consider the impact of the substantial shareholding exemption on corporate shareholders. Where the shareholding by a corporate shareholder exceeds 10 per cent, the substantial 550

Exempt distributions 24.97 shareholding exemption might be applicable on a disposal or deemed disposal of the shares of the distributing company. Given the trading requirements of TCGA 1992, s 1081(2), it seems entirely likely that the conditions for the application of the substantial shareholding exemption will generally be available in these cases. Our starting point on this occasion is TCGA 1992, Sch 7AC, para 4(1)(c), which tells us to ignore TCGA 1992, s 192(2)(b). As we have seen, TCGA 1992, s 192(2)(b) deems the distribution in specie not to be a capital distribution, so the effect here is that, to determine whether the substantial shareholding exemption applies, we must assume that the distribution in specie is a capital distribution and hence a part-disposal by the shareholder. Since we are assuming all the conditions relevant to the substantial shareholding exemption are satisfied, the exemption takes priority over the reorganisation provisions, and TCGA 1992, s 192(2)(b) is ignored, by virtue of TCGA 1992, Sch 7AC, para 4(3)(a). So a corporate shareholder is treated as making a part-disposal of the shareholding in the distributing company, although any gain on that part-disposal is then exempt under paragraph 1 of the substantial shareholding exemption. If the corporate shareholder is not trading, so that the substantial shareholding exemption is not available, then the reconstruction reliefs will apply in the same way as they do to non-corporate shareholders.

Indirect demergers of a trade 24.97 Figure 24.7 Indirect demergers – CTA 2010, s 1077(1)(a)(i)

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24.98 Exempt distributions

In Figure 24.7(a), the trade of the distributing company is distributed to a new company. That new company then issues shares to the shareholders of the distributing company in accordance with CTA 2010, s 1077(1)(a)(i). As a result, all the shareholders of the distributing company also receive shares in the transferee company in the same proportions. In Figure 24.7(b), the intention is to segregate the shareholdings so that one group of shareholders retains shares in the distributing company and the other only has shares in the transferee company. This would be achieved by, first, reorganising the shares of the distributing company into A and B shares. The A shares will only have rights over the distributing company and the trade that it will be retaining. The B shares will only have rights over the trade to be distributed to the transferee company in the demerger. The distribution will then be made in respect of the B shareholders only and only they will receive shares in the transferee company. Again, typically, once the distribution has been made, the B shares in the distributing company will be worthless and will be cancelled or sold for a nominal consideration.

Is it a reconstruction? 24.98 The first test we must consider is whether the transaction we are looking at is a scheme of reconstruction. The availability of various reliefs will of course depend on the answer to this question. Let us first rehearse the four conditions to be satisfied if the transaction is to be a reconstruction per TCGA 1992, Sch 5AA: ●●

there must be an issue of ordinary share capital by at least one transferee company to shareholders of ordinary share capital (or particular classes 552

Exempt distributions 24.100 of ordinary share capital involved in the reconstruction) of the transferor company; and ●●

that share issue by the transferee company must be pro rata to the shareholdings of the relevant classes of ordinary share in the transferor company; and

●●

the business carried on by the transferor company must subsequently be carried on by one or more successor companies; or

●●

there must be a scheme or arrangement under CA 2006, Part 26.

Now, let us turn to the various potential demerger structures to see whether they constitute schemes of reconstruction and what reliefs are available to shareholders or to the distributing company. TCGA 1992, Sch 5AA – the first condition 24.99 Looking at CTA 2010, s 1077(1)(a)(i) (above), it is clear that the transaction involves the issue of shares by the transferee company. So the first condition is clearly satisfied in both examples. TCGA 1992, Sch 5AA – the second condition 24.100 There is nothing in CTA 2010, s 1077(1)(a)(i) to suggest that the shares must be issued pro rata by the transferee company. However, the nature of the rights of shareholders is that all holders of the same class of shares should be treated equally. So it seems likely, again, that in Figure 24.7(a) the issue of shares to each shareholder would necessarily be pro rata to the shareholdings in the distributing company. In any case, even if company law does not require a pro rata issue of shares by the transferee company, it follows from the definition in TCGA 1992, Sch 5AA that this is required for tax purposes. Therefore, the second condition is satisfied or can be made to be satisfied. In Figure 24.7(b), the business of the company is being segregated into two successor companies, one of which is the original company (as defined by TCGA 1992, Sch 5AA, also being the distributing company, as defined by CTA 2010, s 1079) and each company will be owned by a different group of the shareholders of the original company. In this case, we have the preliminary reorganisation of the share capital of the original company, which is tax-free, being an ordinary reorganisation of share capital to which TCGA 1992, s 127 applies and TCGA 1992, Sch 5AA, para 6 tells us that such preliminary reorganisations are also ignored in determining whether the transactions amount to a reconstruction.

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24.101 Exempt distributions The second condition of TCGA 1992, Sch 5AA then requires that the transferee company issues ordinary share capital pro rata to the B shareholders of the original company. This condition is easily satisfied, so in a partition demerger, the second condition is also satisfied. TCGA 1992, Sch 5AA – the third and fourth conditions 24.101 The definition of a demerger is that the original company’s business is separated and subsequently carried on by more than one successor company. Therefore, the third condition is satisfied. In this case, the demerger is by distribution of a trade from the transferor company, so one of the successor companies is also the original company. Since only one of the third or fourth conditions needs to be satisfied, we do not need to look at the fourth condition. However, we have concluded (in Chapter 22) that a demerger where the shareholders are not segregated (as in Figure 24.7(a)) is capable of being a scheme of reconstruction for company law purposes, so the transaction could theoretically be carried out by court order under CA 2006, s 900. 24.102 Thus we have demonstrated that a demerger by distribution in specie of a trade is a reconstruction as defined by TCGA 1992, Sch 5AA. Again, matters are far more straightforward in this respect than before the introduction of that definition when it was then necessary to rely on Statement of Practice 5/85 or the predecessor Press Release in the case of a partition demerger.

Reliefs for distributing company 24.103 At the company level, relief from the charge to corporation tax on chargeable gain is given by TCGA 1992, s 139 whereby the transfer of the trade is deemed to be at such a consideration as to give no gain and no loss for capital gains purposes. This treatment applies to both the transferor company, which thereby has no chargeable gain, and to the transferee, which thereby has a base cost equal to the transferor’s base cost (including indexation if applicable). TCGA 1992, s 139 is discussed in Chapter 18 but here is a reminder of its requirements: ●●

there must be a scheme of reconstruction (TCGA 1992, s 139(1)(a));

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there must be a transfer of all or part of the company’s business to another company (TCGA 1992, s 139(1)(a));

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Exempt distributions 24.104 ●●

the companies must be UK tax resident or within the charge to UK corporation tax on chargeable gains (TCGA 1992, s 139(1)(b), (1A)); and

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the transferor company must not receive any consideration for the transfer (TCGA 1992, s 139(1)(c)).

We clearly satisfy the first of these requirements by virtue of being a TCGA 1992, Sch 5AA reconstruction and, by satisfying the third condition of TCGA 1992, Sch 5AA, the business transfer condition, we satisfy the second requirement. Let us assume that the third requirement is satisfied for the purposes of our examples and the fourth requirement is satisfied in a distribution as no consideration is given for distributions. Overall, therefore, it is clear that both of the examples given above fulfil the requirements for the corporate relief given by TCGA 1992, s 139 to apply. The transfer of assets to the new companies will be on a ‘no gain no loss’ basis. Accordingly, the distributing company will not be chargeable to corporation tax on a chargeable gain and the trade and assets will be treated as having been acquired by the transferee company at the original cost and, for the purposes of indexation, at the date they were originally acquired. For completeness, we would note that the substantial shareholding exemption cannot apply to the distributing company in this form of transaction as the assets being distributed are not shares or assets related to shares.

Reliefs for non-corporate shareholders 24.104 So far as the shareholders are concerned, in either transaction, the results will be much the same as for the direct demergers, albeit partly for different reasons. First, the transaction is not an income distribution, this being, again, simply the result of the application of CTA 2010, s 1075. But there is no provision to prevent the distribution therefore being a capital distribution, so we need to see whether TCGA 1992, s 136 can apply instead. The three primary conditions for TCGA 1992, s 136 to apply are (as always, we are assuming for all purposes that the demerger is being carried out for bona fide commercial reasons and not for the avoidance of tax): ●●

there must be an arrangement between a company and its shareholders (TCGA 1992, s 136(1)(a));

●●

this must be for the purposes of a scheme of reconstruction (TCGA 1992, s 136(1)(a));

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24.105 Exempt distributions ●●

another company must issue shares to the shareholders of the first company pro rata to their shareholdings in that company, whether those original shares are retained or cancelled (TCGA 1992, s 136(1)(b)).

Generally, again, we would expect these demergers to be the result of an arrangement between the distributing company and its shareholders and that arrangement would always be for the purposes of the scheme of reconstruction that is the demerger and the final condition is again satisfied by virtue of satisfying the pro rata share issue requirement of the second condition of TCGA 1992, Sch 5AA. So the requirements of TCGA 1992, s 136 are clearly satisfied for both the partition and non-partition examples and the TCGA 1992, s 136 relief is available deeming the transaction to be treated as if there has been a reorganisation of the share capital of the distributing company, which is why the result is so similar to that of the indirect demerger. In Figure 24.7(a), the shareholders end up with shares in both the distributing company and the transferee company. Those shares are treated as if both sets of shares were acquired at the same time and for the same total price as the original shares held in the distributing company. The base cost is split between them as described in Chapter 6. In Figure 24.7(b), the first step, reorganising the share capital into A and B shares, is a reorganisation to which TCGA 1992, s 127 applies. So there is no disposal and each shareholder has the same base cost in their A or B shares as they had in the original ordinary shares they acquired. For the A shareholders, who merely retain the shareholdings in the distributing company, that is the end of the matter. For the B shareholders, who have shares in the transferee company after the distribution, the original base cost of their shares is theoretically split between the B shares of the distributing company and the shares of the transferee company. However, in practice, the B shares of the distributing company are, again, generally worthless, so the practical result is that the shareholders now have the same base cost in the shares of the transferee company as in the original holding in the distributing company.

Reliefs for corporate shareholders 24.105 As for direct demergers, corporate shareholders may benefit from the substantial shareholding exemption rather than from the reorganisation provisions imposed by TCGA 1992, s 136.

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Exempt distributions 24.106 In this case, we need to consider TCGA 1992, Sch 7AC, para 4(1)(b) (as TCGA 1992, s 192(2) only applies to direct demergers). TCGA 1992, Sch 7AC, para 4(1)(b), with para 4(5), tells us to ignore the reorganisation provisions of TCGA 1992, s 127, as applied by TCGA 1992, s 136, in determining whether there is a disposal to which the substantial shareholding exemption might apply. So, again, we assume that the distribution in specie is a capital distribution to which the reorganisation provisions do not apply. As before, assuming all the conditions relevant to the substantial shareholding exemption are satisfied, then the substantial shareholding exemption would apply in such a hypothetical scenario. That being the case, the substantial shareholding exemption takes priority here and the reorganisation provisions are ignored, by virtue of TCGA 1992, Sch 7AC, para 4(3)(a). So a corporate shareholder is treated as making a capital part disposal of the shareholding in the distributing company, although that part disposal is then exempt under paragraph 1 of the substantial shareholding exemption. If the corporate shareholder is not trading, so that the substantial shareholding exemption is not available, then the reconstruction reliefs will apply in the same way as they do to non-corporate shareholders.

Indirect demergers – subsidiaries 24.106 Figure 24.8 Indirect demergers – CTA 2010, s 1077(1)(a)(ii)

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24.107 Exempt distributions

In Figure 24.8(a), the subsidiary of the distributing company is distributed to a new company. That new company then issues shares to the shareholders of the distributing company in accordance with CTA 2010, s 1077(1)(a)(ii). As a result, all the shareholders of the distributing company also receive shares in the transferee company in the same proportions. In Figure 24.8(b), the intention is to segregate the shareholdings so that one group of shareholders retains shares in the distributing company and the other only has shares in the transferee company. This would again be achieved by, first, reorganising the shares of the distributing company into A and B shares. The A shares will only have rights over the distributing company and the subsidiaries and/or trades that it will be retaining. The B shares will only have rights over the subsidiary to be distributed to the transferee company in the demerger. The distribution will then be made in respect of the B shareholders only and only they will receive shares in the transferee company. Again, typically, once the distribution has been made, the B shares in the distributing company will be worthless and will be cancelled or sold for a nominal consideration.

Analysis 24.107 The analysis is almost identical to that for Figure 24.7(a) and (b) showing the demerger of a trade. In each case, the only difference is that the activity transferred is that of a trading subsidiary rather than the trade itself, but holding a subsidiary counts as a business for the purposes of TCGA 1992, s 139 and so the analysis at both shareholder and corporate level will be the same. Where the distributing company is disposing of shares in subsidiaries, the substantial shareholding exemption does not apply for the same reason as

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Exempt distributions 24.110 detailed under the analysis for liquidation demergers, ie because the exemption cannot apply to deemed ‘no gain no loss’ disposals.

Further tax issues on distribution demergers TCGA 1992, s 179 charges 24.108 In many cases, the various subsidiaries in a group of companies are not segregated into clear sub-groups, so that any form of demerger will require some internal reorganisation before the demerger is effected. This means that transferee companies might have an exposure to capital gains exit charges under TCGA 1992, s 179, or exit charges under the intangibles regime, CTA 2009, s 780, by virtue of having had assets transferred to them during the preliminary reorganisation of the group. As we saw with liquidation demergers (Chapter 23), the usual way to avoid this problem is to demerge each asset separately under the protection of TCGA 1992, s 139. However, as we have seen, exempt distributions have a specific exemption from TCGA 1992, s 179 charges, in TCGA 1992, s 192(3). As a result, it is possible to transfer all the assets and companies to be demerged into a single demerger entity, which can then be demerged without the tax constraint of TCGA 1992, s 179 charges. There is a similar protection from the intangibles degrouping charge at CTA 2009, s 787. These provisions permit far greater flexibility in terms of reorganising a group prior to the demerger in comparison with other forms of demerger.

Capital allowances balancing charges 24.109 The demerger of a trade, rather than of a trading company, by way of distribution in specie under CTA 2010, s 1077(1)(a)(i) could generate capital allowance balancing charges as with liquidation demergers and for all the same reasons. The obvious resolution is to consider whether the trade could be hived into a new subsidiary, that subsidiary being the subject of the distribution instead (remember, there is an exemption from the TCGA 1992, s 179 charge that would otherwise arise). Alternatively, if the transfer of one of a company’s trades would generate a balancing charge, the demerger of the other trade might not, so the demerger route could be reversed.

Group hold-over relief unwinds 24.110 This is exactly the same point as discussed under liquidation demergers. Again, one possible answer is to consider whether the problem 559

24.111 Exempt distributions goes away if the demerger is carried out the other way. If this does not prove possible, then a demerger by return of capital might be the preferred answer (or even the only viable answer, as the authors have seen on one occasion).

Commercial issues on distribution demergers Distributable reserves 24.111 As is clearly implied by the structure of the transactions described in CTA 2010, ss 1076, 1077 and 1078, a distribution in specie can only be carried out if there are sufficient distributable reserves for the distributing company to distribute the trade or subsidiary to be demerged. If the distributing company does not have sufficient reserves, the distribution would not be lawful. The reserves must be the same as or exceed the book value of the asset to be distributed. There are, of course, various methods available to create or increase distributable reserves, which is a matter of company law and outside the scope of this tome. So it is always imperative to retain close contact with the company’s lawyers and accountants when carrying out transactions of this nature.

CONCLUSION 24.112 The exempt distribution route is, in many ways, by far the simplest route to carrying out a demerger with a most comprehensive set of tax reliefs. It is unfortunate that the relief is only open to trading groups and companies, and it is disappointing that the reform of corporation tax promised in the Budget of 2006 was not pursued, so that the legislation is still restricted to demergers of trades and trading companies.

STAMP TAXES AND DISTRIBUTION DEMERGERS Direct demergers 24.113 A direct demerger of a subsidiary by distribution is a transfer for no consideration on which no stamp duty should arise. As usual, care must be taken to ensure that the change of ownership of the subsidiary does not disturb any previous claims to relief from SDLT, LTT or LBTT. In the past the Stamp Office has been known to allege that declaration of a final distribution creates a money debt, satisfied by the transfer of the subsidiary to the shareholders, thus rendering it a transfer for consideration. To guard against this, the 560

Exempt distributions 24.117 resolution to distribute the shares should make it clear that there is no question of shareholders becoming entitled to cash. As a belt-and-braces approach, the distribution could be declared as an interim dividend, since under UK company law this does not create any debt.

Indirect demergers 24.114 An indirect demerger may take place by transfer of shares of a subsidiary, or assets and liabilities of a business, to another company in return for the issue of shares by that second company to the shareholders of the first. Even though this may be a distribution for other purposes, it is a transfer for consideration for stamp duty purposes, but is capable of qualifying for stamp tax reconstruction relief as explained in Chapter 2. The conditions for relief are similar to some of those for a distribution to qualify as ‘exempt’ under CTA 2010, s 1075, but the stamp tax reliefs may be available whether the transfer is an exempt distribution or not.

VALUE ADDED TAX Direct demerger 24.115 See 24.15 above.

Position of the ultimate shareholders 24.116 The position of an ultimate shareholder as always depends on whether or not he carries on a relevant business in relation to the distributing company and to the subsidiary or subsidiaries which he is to acquire. Often he will not. If he does not, he can, of course, recover no input VAT on any incidental expenses incurred by him for the purpose of the exercise. If he is carrying on a relevant business then, of course, the exercise does not constitute a supply by him: he is simply receiving shares in a subsidiary by way of a distribution. If he is carrying on a business in relation to the shares any input VAT incurred by him in connection with the exercise should count as input VAT of that business. This is so whether or not the distribution counts as a TOGC, see 3.12 and 3.13.

Position of the distributing company 24.117 The exercise does not involve the distributing company making a supply, that is a supply for a consideration: consideration is necessary if 561

24.118 Exempt distributions something is to be a supply for VAT purposes. The transaction is simply the making of a distribution of shares in specie, and that is not a supply. Let us suppose that the distributing company is carrying on a relevant business in relation to its shares in the subsidiary (see 3.6). Any input VAT incurred by the distributing company on the costs of the exercise will be regarded as incurred for the purpose of the business that it has in relation to the subsidiary. If that, for example, is the rendering of taxable management services the input VAT should be wholly recoverable. If the distributing company is VAT-grouped with the subsidiary any input VAT should in practice be regarded as input VAT attributable to the business of the subsidiary.

Position of the subsidiary or subsidiaries being demerged 24.118 A subsidiary does not, of course, itself make any supply itself as part of the exercise. It is not very likely that it will incur expenses in relation to the exercise, but if it does the input VAT on them should be residual input VAT of its business.

Indirect demerger of trade 24.119 See 24.97 above.

Position of the ultimate shareholders 24.120 Their position is the same as in the case of a direct demerger, see 24.116 above.

Position of the distributing company 24.121 The exercise will almost always be a TOGC, and will not be a supply by the distributing company for VAT purposes. Reference should be made to 3.12 and 3.13, where the position is explained in more detail. In brief, input VAT on any expenses incurred by it for the purpose of the exercise should be treated as input VAT of the trade being demerged.

Position of the New Co or New Cos 24.122 A New Co will make no supply in the course of the exercise: it will acquire a trade by way of a TOGC and the issue of shares by it will not count as a supply. It may incur little or no expenses itself in connection with the

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Exempt distributions 24.127 exercise, but the input VAT on any expenses it does incur should count as input VAT attributable to the general activities of the trade it is acquiring. Any New Co that will be making taxable supplies should register for VAT, as an intending trader, as soon as it forms the intention to do so.

Indirect demerger of subsidiary 24.123 See 24.106 above.

Position of the ultimate shareholders 24.124 Their position is the same as in the case of a direct demerger, see 24.116 above.

Position of the distributing company 24.125 Suppose that the distributing company is carrying on a relevant business in relation to the shares in the subsidiary. The distributing company is, in our view, making no supply for VAT purposes: see 24.26 above. Its position is therefore the same as in the case of a direct demerger, see 24.1167 above.

Position of the New Co or New Cos 24.126 The first question is whether the New Co will be carrying on a relevant business in relation to its shares in the subsidiary being demerged to it: see 3.7 above. The New Co may not incur any expenses to speak of in relation to the demerger exercise but, if it does, it will not be carrying on a business so it cannot recover any input VAT on them. If it will be carrying on a business of rendering taxable management services to the subsidiary, for example, it should be able to recover any input VAT incurred by it for the purpose of the demerger exercise. Its position is akin to that of the buyer in the case of a sharefor-share exchange, and it should plan and proceed as set out in 8.26 above.

Position of the subsidiary or subsidiaries being demerged 24.127 A subsidiary does not, of course, make any supply itself as part of the exercise. It is not very likely that it will incur expenses in relation to the exercise but, if it does, the input VAT on them should be residual input VAT of its business.

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Chapter 25

‘Return of capital’ demergers

INTRODUCTION AND COMMERCIAL PURPOSE What is it? 25.1 This form of demerger has been found to be useful in a variety of circumstances where neither a liquidation demerger nor an exempt distribution have been appropriate, perhaps for some of the reasons detailed in the relevant chapters. The essence of this form of demerger is that the businesses to be demerged are distributed as the in specie consideration for the reduction of capital by a company. Before the changes in Companies Act 2006, this had to be approved by the courts, which was an expensive process and hence rarely used in the SME market. But the amended process of reducing capital by the solvency statement process has opened up this mechanism to a much wider market. In one sense, the transaction represents a half-way house between a full liquidation and a distribution (indeed, in the USA, a very similar-looking transaction is referred to as a ‘partial liquidation’ as in Lazard v Rae, 41 TC 1). This form of transaction was not lawful under English company law until CA 1985, but it has since been used in a number of high-profile public company demergers since the mid-1990s. Of particular note are the demergers of Carillion from Tarmac, Lonrho Africa, Intercontinental Hotels and M&B from Six Continents, Allied Domecq, Granada Compass and a number of others.

Why do it? 25.2 This is probably the most difficult and time-consuming mechanism for achieving a demerger. So why would anyone use it? In our experience, there can be a number of reasons for using this demerger mechanism, even though it is unlikely to have been the first choice of the parties concerned. The most common issue is a lack of sufficient distributable reserves to be able to distribute the specific business units in specie, so the exempt distribution route and the reliefs under CTA 2010, Part 23, Chapter 5 (ss 1073–1099, 564

‘Return of capital’ demergers 25.3 exempt distributions) are not available. The other most common reason why the exempt distribution route is inappropriate is where the activities of the company or group are such that it does not qualify as a trading group, which is the prime condition precedent for being able to use the exempt distribution route. We have, however, also seen a variety of other reasons why the exempt distribution demerger might not be appropriate or viable, as mentioned in previous chapters. Tax issues we have seen that have made this route unacceptable include the potential crystallisation of a held-over chargeable gain on a reinvestment of the proceeds of disposal of business assets and value shifting. These are only the tax issues, and other demergers have had to use this approach for regulatory or commercial reasons. One particularly difficult case involved a group whose holdings were all less than 75 per cent in non-UK subsidiaries, largely because of the regulatory requirements of the countries in which the subsidiaries were incorporated or active. The major reason for not demerging by liquidation is, as discussed earlier, the commercial concerns about putting a high-profile public company into liquidation, which is always seen as a negative matter, whatever the commercial reality might be. Furthermore, liquidation reconstructions require the services of an insolvency practitioner and advice on various areas of insolvency law, all of which complicate matters and add both costs and time to transactions. In the case of our private company client (mentioned at the end of 25.1), the capital allowances balancing charge was the major reason that we could not use the liquidation approach, but it was in that case that we saw the emotional concern too. The company was an old family company, set up nearly a century earlier, and the shareholders, while keen to demerge and run the component parts of the group independently, were also very keen to retain the old original company. So a liquidation of that company was out of the question. For a property investment company, a reduction of capital demerger may also be free of SDLT when a charge may arise on other demerger mechanisms.

LEGAL BACKGROUND Introduction 25.3 In essence, when undertaking a demerger, a company reduces its share capital and the shares in a subsidiary or the business to be demerged are transferred to a new company, which then issues shares to the shareholders in consideration for the transfer of the subsidiary or the business. Thus, in 565

25.4 ‘Return of capital’ demergers Figure 25.1 Hold Co reduces its capital by £100 and the consideration is the transfer of a subsidiary with a book value of £100. This transaction is therefore very similar to the demerger by distribution under CTA 2010, s 1077(1)(a)) (i) or (ii). The main difference is that in the distribution route the distributable reserves are used as the legal method of passing assets to shareholders, while here the cancellation of the share capital either creates distributable reserves or creates the ‘pot’ of capital which can be returned directly. It is the cancellation of share capital that gives these transactions the name we occasionally see, the ‘partial liquidation’. Figure 25.1

In general terms, the intention is that the demerger be a reconstruction, so that the appropriate reliefs under TCGA 1992, ss 136 and 139 will apply to the shareholders and the distributing company. We will look at this analysis in more detail later.

Demerger by reduction of capital 25.4 It is a basic common law principle that the capital of a company should be maintained and capital cannot be returned except in certain prescribed ways, for example, a purchase of own shares in accordance with the provisions of CA 2006 or a reduction of capital in accordance with the provisions of CA 2006, being either a court-approved reduction of capital where creditors will not be adversely affected or a reduction of capital supported by a solvency statement in the case of a private company. Public companies can only undertake reductions of capital approved by the court. Private companies have a choice of method and most commonly use the solvency statement route.

Court-approved capital reduction 25.5 With the approval of the court and the passing of a special resolution of its shareholders, a company may lawfully reduce its share capital. For example, 566

‘Return of capital’ demergers 25.5 a company with £1000 of issued share capital divided into 1000 shares of £1 each wishing to reduce its share capital to £500 may, following the approval of its shareholders, apply to court for the court to confirm the reduction of its share capital. The reduction can be effected either by reducing the nominal value of each share from £1 to 50p or by the cancellation and extinguishment of 500 shares of £1 each. These routes would leave the company with 1000 shares of 50p each or 500 shares of £1 each respectively. The value created by the reduction of capital can then either (i) be returned to the shareholders by way of a return of capital, (ii) a capital reserve can be created against which a retained loss on the profit and loss reserve can be set, and, subject to the company having sufficient distributable reserves, can then be distributed to shareholders, or (iii) assets can be distributed or returned to shareholders by way of an in specie distribution. The court will only confirm the reduction of capital once it is satisfied that all the creditors of the relevant company are protected. In the most straightforward scenarios, the company would have no creditors or all creditors would consent to the proposed reduction. However, where the company has creditors which have not consented to the proposed reduction, the court will require the company to put in place adequate safeguards for the protection of those creditors. In practice, the protection given by the company most commonly takes one, or a combination, of three forms: ●●

the company undertakes to the court to credit the proceeds of the reduction of capital to a non-distributable special reserve which will remain in place until all creditors of the company at the date of the reduction have been discharged; or

●●

an amount equal to that owed to the non-consenting creditors be transferred to a blocked bank account which will be used solely to meet the liabilities of those creditors as they fall due; or

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a guarantee, given usually by a parent company or a bank, that to the extent that the company fails to pay any liability owed to a nonconsenting creditor at the date of the capital reduction, it shall pay such liability as guarantor.

It should also be noted that it is always open for interested persons to object to the reduction of capital of a company, although if the court considers that the company is providing adequate creditor protection, unless there are extraneous circumstances, it is unlikely that the reduction would be refused because of such an objection. The type of protection that the company may need to give may impact upon the feasibility of a reduction of capital for the purposes of achieving the demerger. If the company is a large trading company with a large number of creditors, obtaining those creditors’ consent may not be practical and so the company 567

25.6 ‘Return of capital’ demergers will need to provide creditor protection as outlined above. Placing funds in a blocked bank account or giving an undertaking to the court that the value will not be distributed to shareholders until all the creditors at the time of the reduction have been settled may not be feasible, as this would prevent the company from effecting the demerger. If a liquidation demerger is also not feasible, alternative structures will need to be looked at.

Reduction of capital supported by a solvency statement 25.6 The CA 2006 introduced, with effect from 1 October 2008, a new procedure which permits a private limited company (not a public limited company) to reduce its capital without the need to receive confirmation of the court. This is in addition to the court approved reduction of capital route referred to above. The reduction of capital, if approved by the shareholders, can be effected in the same ways as a court approved reduction of capital as described above, namely either by reducing the nominal value of each share or by the cancellation and extinguishment of a number of shares. In addition, the value created by the reduction can be treated in the same ways as value created through a court-approved reduction of capital, namely either (i) being returned to the shareholders by way of a return of capital, or (ii) by way of a distribution out of the realised profits thereby created. Capital Reduction Order 2008, art 3(3)(b) provides that the reserve arising from a court-approved capital reduction is to be treated as a realised profit unless the court otherwise orders. It does not appear from available records that any such order has been made. A court can, however, require a company to put in place an agreed form of creditor protection such as an undertaking not to distribute any reserves until all relevant creditors have consented or been paid in full or otherwise been discharged. Unlike a court-approved capital reduction, there is no statutory procedure for an investigation into the position of creditors of the company to take place, and it is for the directors to ensure, in the proper discharge of their duties to the company, that creditors are protected. The directors of the company are also required to make a statement as to the solvency of the company on both a net asset and cash flow basis and, when making that statement, are required to take into account all the company’s liabilities, including any contingent or prospective liabilities. If a director makes a false statement without having reasonable grounds for the opinions expressed in it, he commits an offence which is punishable by way of a fine and/or imprisonment. It is also worth noting that, unlike the procedure for effecting a purchase of own shares out of capital where the directors of the company also have to make a statement as to the solvency of the company, there is no requirement 568

‘Return of capital’ demergers 25.7 for the auditors of the company to prepare a report into the affairs of the company. However, it is recommended that the auditors are asked to review the company’s finances so as to give the directors some comfort when making the statement as to the company’s solvency. Whilst the procedure is much more flexible and simpler than a court-approved reduction, the responsibilities placed on directors are greater. We will consider the legal process for a reduction of capital later in this chapter.

Interaction with the distributions legislation 25.7 In Figure 25.1, we showed an asset with a book value of £100 being transferred in consideration for the reduction of the nominal issued share capital by £100. This is fine if the market value and book value of the asset are the same. However, this is rarely (if ever) the case, and we need to consider the distributions legislation, too. CTA 2010, s 1000(1)B tells us that any amount distributed to shareholders in excess of the repayment of actual capital subscribed will be an income distribution to the shareholders. What if the market value of the asset had been £1,500? In legal terms, Hold Co only needs to reduce its capital by the book value of £100 to be able to transfer B to the shareholders. However, if Hold Co reduces its capital by £100 and the consideration is company B, which is worth £1,500, there is a prima facie distribution of £1,400 under CTA 2010, s 1000(1)B. This is not an exempt distribution, as we are not within CTA 2010, Part 23, Chapter 5, and it is not a capital distribution, because the company is not in liquidation. So none of the capital gains reliefs can apply to the distribution element. This is clearly an unsatisfactory result to the shareholders, who would be charged to income tax. The company would have suffered a charge to ACT, too, before its abolition in 1998. Given the numbers involved, the amount of ACT could easily be substantially more than the amount of corporation tax payable by the distributing company in respect of its profits for that year or, indeed, for many years to come. However, with the abolition of ACT, the distribution is more of a shareholder problem than a company matter. The simplest solution is to reduce the capital of the distributing company by the market value of the asset, rather than just by the book value. Referring to Figure 25.1, again, let us assume that Hold Co has share capital of £2,000, instead. Hold Co could therefore reduce its capital by £1,500, being the market value of B, and distribute B at market value to the shareholders. The entire distribution represents a return of capital and there is no income distribution element under CTA 2010, s 1000(1)B. However, usually we find that the

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25.7 ‘Return of capital’ demergers market value of the subsidiary to be demerged is high in comparison to the paid up capital of the proposed distributing company, so that this solution is not available, because a company cannot return capital in excess of the nominal capital (broadly, share capital plus share premium). It is possible, under company law, to enhance the share capital by revaluing the asset and capitalising the revaluation reserve by way of a bonus issue of shares. A reduction of capital could then ‘drive’ the transfer of the asset to the shareholders. However, the tax analysis would be a reduction of capital following a bonus issue, which is treated as a distribution by CTA 2010, s 1026. The normal solution is to insert a new holding company above the distributing company, as shown in Figure 25.2. Figure 25.2 Insertion of Top Co Top Co

Hold Co A

Top Co

Hold Co

Hold Co B

A

B

A

B

Top Co

New Co

Hold Co

B

A

(a) Top Co inserted by share-for-share exchange (b) Top Co issues share capital equal to market value of group (C) B transferred to Top Co, so that carrying value of B is equal to market share

Let us assume that companies A and B each have a market value of £1,500, so the group value is £3,000. When Top Co, the new company, is inserted it can issue share capital with a nominal value equal to the market value of the group as a whole, £3,000. So far as the distributions legislation is concerned, CTA 2010, s 1115 tells us that the value subscribed for shares in Top Co is ‘new consideration’. That is, it is treated as an investment of funds from outside the group. So, for tax distributions purposes the shareholders of Hold Co in Figure 25.2 are assumed to have subscribed assets worth £3,000 – the value of their shares in Hold Co – for shares with both nominal value and new consideration of £3,000. Company B can be transferred to Top Co, typically by a distribution in specie, which will usually mean that minimal distributable reserves will be required in Hold Co. Then, Top Co can reduce its capital by £1,500 and transfer company B to New Co, which has a market value of £1,500, as consideration. Thus the consideration for the reduction of capital, the shares of company B, is numerically equivalent to the amount subscribed for the shares that are cancelled, so that CTA 2010, s 1000(1)B(a) treats the entire amount as a return of capital and there is no element of distribution.

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‘Return of capital’ demergers 25.9 The final leg of the transaction is that New Co will issue shares to the shareholders of Top Co pro rata to their holdings of shares of Top Co. This will ensure that they are effectively remunerated for the cancellation of their shares in Hold Co and also satisfies the first condition for this part of the transaction to be a scheme of reconstruction for corporation tax and capital gains tax purposes (see 16.5 et seq and 25.14).

Insertion of new top company 25.8 The insertion of the new company can either take place by way of a share-for-share exchange (see Chapter 8), a takeover offer in accordance with CA 2006, Part 28 or by cancelling the shares of Hold Co and issuing new shares to the new company, which issues shares to the shareholders of the holding company. This can be done as a scheme of arrangement under CA 2006, Part 26, requiring a court order, but for most small companies, we are able to do it without a court order. The consequences of these transactions have already been discussed earlier in this book and should be deemed reorganisations and hence tax-free so far as the shareholders are concerned. On inserting a new company, the shareholders of the holding company would expect to get capital gains relief under TCGA 1992, s 135 (for a share exchange) or TCGA 1992, s 136 (for a scheme of reconstruction) so that the capital gains base cost of the shares in the new holding company is the same as that for their shares in the original holding company.

Valuation issues 25.9 It is clear that the process of demerger by this mechanism will require a valuation of the group as a whole and of the sub-group or business to be demerged. The value of the group will inform the amount of share capital to be issued by the new company and the value of the business or shares to be demerged will inform both the transfer value to the new holding company and the quantum of capital to be reduced. Both these valuations will have been carried out in advance of the transactions, and it is important to ensure that the entire process of demerger is carried out as quickly as possible to prevent any changes in circumstances having a material impact on the valuations. To demonstrate this, let us return to our example group in Figure 25.2, which is worth £3,000. We are intending that the new company issues £3,000 of ordinary share capital on acquiring the group, but if there is a dramatic market downturn immediately before the first court appearance so that the group is only worth £2,800, then to issue shares with a nominal value of £3,000 would be to issue the shares at a discount, which is unlawful.

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25.10 ‘Return of capital’ demergers Conversely, after inserting the new company, we have new consideration of £3,000 underlying the shares. The court papers and shareholder resolutions will all have been prepared on the basis that the company’s share capital will be reduced by £1,500 and the consideration to the shareholders will be assets with a book and market value of £1,500. Once all the paperwork has been put in place and court approval also obtained, it is very difficult to alter the documentation and court approval if the value of the business to be demerged has increased by 10 per cent to £1,650, but to reduce the share capital by £1,500 and give consideration worth £1,650 would leave the shareholders with an element of distribution in the transaction, which is exactly what we are trying to avoid. So the valuation process is crucial to making these types of demerger work and it is important that the process be carried out in such a way that the valuations team can react very quickly if there is a sudden market change. That said, the valuation process can itself be complex and time consuming, and a major change in the market environment might require a delay in completing the transaction.

The legal process 25.10 The precise details of the legal process for the reduction of capital demerger are not a matter for this book, however, it is useful to have a highlevel overview of the process and the timing involved. Where the demerger is to be effected by means of a court approved reduction of capital rather than a reduction of capital supported by a solvency statement or a scheme of arrangement, the board of directors would meet to approve the capital reduction and to convene a general meeting of the company. After the appropriate notice period had passed, usually 14 days, the general meeting would be held at which the shareholders should approve the capital reduction. In addition, any class consents (consenting to variation of class rights) that may be required from holders of other classes of shares should be passed. Documents, typically the petition of the company, application for directions and supporting witness statements of the chairman and registrar/printer/mailing house, are then lodged with the court, with the hearing of the application for directions following 14 days later. Following this hearing, the proposed reduction must be advertised in the national press, with the final hearing of the petition in open court following not less than seven days after the publication of the advertisement. The order confirming the reduction having been made by the court, it should then be registered with the Registrar of Companies, at which time the reduction becomes effective. A further advertisement must be placed in the national press confirming the registration of the order. The entire process from the first board meeting to registration of the order would

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‘Return of capital’ demergers 25.10 therefore typically take at least eight weeks. However, there is likely to be significant preparation time involved prior to the directors being in a position to meet and approve the reduction. When undertaking a reduction of capital approved by a solvency statement, the board of directors would meet to approve the capital reduction and to convene a general meeting. After the appropriate notice period had passed, usually 14 days – or earlier if shareholders agree to the meeting being held on short notice – the general meeting would be held at which the shareholders should approve the capital reduction. Alternatively, the resolution can be passed by way of a written resolution, which removes the need for a meeting. At that board meeting, the directors of the company would also usually make the solvency statement. When making that statement, each of the directors is confirming that they have formed the opinion that, at the date of the statement, there is no ground on which the company could then be found to be unable to pay (or otherwise discharge) its debts and either (i) if it is intended to commence the winding up of the company within 12 months of the date of the statement, that the company will be able to pay (or otherwise discharge) its debts in full within 12 months of the commencement of the winding up, or (ii) in any other case, that the company will be able to pay (or otherwise discharge) its debts as they fall due during the year following the date of the statement. This statement must be made not more than 15 days before the date on which the special resolution of the shareholders of the company approving the reduction of capital is passed. The reduction of capital will take effect once the Registrar of Companies has registered the special resolution, the solvency statement and a statement of the company’s capital following the reduction of capital. However, if the reduction is part of a scheme of arrangement (which will still require a court order), the reduction will take effect upon delivery of the court order and the statement of capital to the Registrar of Companies. The addition of a new holding company via a scheme of arrangement is a complicating factor. If the scheme of arrangement, including the insertion of the new holding company, and the reduction of capital of the new holding company to effect the demerger were both actioned sequentially, the whole process would take at least 18 weeks to complete (allowing for the relevant notice periods for the shareholder meetings and the court hearings – see below for example timetables). This would, obviously, not be ideal given the comments above relating to the valuation issues. In order to overcome these problems, it is usual for the court and shareholder approvals for both the scheme of arrangement and the reduction of capital to run in parallel. The effective date of the scheme (the date on which the new holding company is inserted) should be as short a time as possible before the hearing to confirm the reduction of capital of the new holding company. The steps must happen in this order as the scheme of arrangement must be effective in order for the demerging company to be part of the demerging group, to be the owner of the 573

25.10 ‘Return of capital’ demergers subsidiary/business being demerged and to have issued the relevant shares which are to be the subject of the reduction of capital. The typical timeframe for a scheme of arrangement is 10 weeks. Seven days following the issue of the claim form by the company, the hearing of the claim form takes place and draft documents, including the scheme document, are submitted to the Registrar of Companies. Court-convened meetings of the relevant classes of members and creditors will be held usually not less than 14 days later. At each of these meetings, the resolution approving the scheme must be passed by a majority in number representing 75 per cent in value of the class of members or creditors who vote at the relevant meeting. The petition and supporting witness statements are then filed with the court prior to the hearing of the petition. At this hearing, providing that all scheme conditions have been fulfilled, the order confirming the scheme will be given. The scheme of arrangement becomes effective upon the filing of the order with the Registrar of Companies. Clearly, where both a scheme of arrangement and a reduction of capital (whether court approved or supported by a solvency statement) are being undertaken together, consideration must be given to the order of events and a more detailed timetable will need to be agreed with the court. A key difficulty associated with running the two approval processes in parallel is that the shareholder approvals for the reduction of capital of the new holding company are required to be passed before that company is a member of the demerging group and its only shareholders will be its subscribers. Indeed, the shares to be the subject of the reduction will not be in existence at the time of the resolution as the business of the current holding company has not been transferred to it and the shareholders affected by the demerger will not yet be shareholders of the company. Using the previous example, the shares of the current holding company with a value of £2,000 have not yet been transferred to the company, in return for which the new holding company issues 2,000 shares to the current shareholders of the holding company. This will not actually take place until such time as the scheme of arrangement is approved by the court and becomes effective. Notwithstanding this, the technical requirements of CA 2006, s 645 can be satisfied by the passing of a resolution of the subscriber shareholders, being the shareholders of the company at the time. However, the court will consider the relevant proposals as a whole and, therefore, in order to ensure that the court approves the reduction of capital, given that it will affect persons who are not yet shareholders of the company, a resolution approving the demerger and the consequent reduction of capital is usually put to the shareholders of the current holding company (the persons who are to become shareholders of the new holding company) for their approval, despite this not strictly being required. It simply serves to demonstrate the wishes of those persons who will become shareholders of the new holding company and therefore will be affected by the reduction of capital and the demerger. 574

‘Return of capital’ demergers 25.11 As noted above, the value of the reduction of capital must be sufficient to be at least equal to the market value of the subsidiary/business being demerged in order to ensure that there is no distribution to shareholders. One way to overcome this problem is by leaving the amount of the reduction to be determined by the directors of the company on the morning of the court hearing taking advantage of the most up to date information at that time. If the demerger involves listed companies, running the two approval procedures in parallel ensures that there is as short a time as possible between the shares of the listed company being delisted and the listing of the shares in the new holding company. One other thing to bear in mind is the court holidays. The court is traditionally closed over the summer months and it is notoriously difficult to get anything through the courts quickly during the summer period. This needs to be factored into any timetable and the court dates fixed as early as possible during the planning of the transaction.

Timetable for capital reduction and scheme of arrangement running in parallel 25.11 Date

Capital reduction Book court dates and prepare documents

D-52 D-49

D-44

575

Scheme of arrangement Book court dates and prepare documents Issue claim form Swear and file witness statements in support of claim form exhibiting draft circular (to be filed not less than two business days before the hearing of the claim form) Hearing of claim form. Submit scheme document containing notice of the meeting and explanatory statement if required. Advertise notice of court meeting in the newspapers as directed by the court

25.11 ‘Return of capital’ demergers Date D-42

D-38 D-27

D-26

Capital reduction Board meeting to approve (a) reduction of capital, (b) calling of the GM and class meetings if relevant, (c) approving documents and (d) authorising chairman/ managing director to swear affidavit. Post circular to shareholders, including the notice of the GM and separate class meetings, if relevant, and proxy forms. Registrars/printers to swear affidavit of posting/printing if required

Scheme of arrangement

Posting date General meeting to pass special resolution(s) reducing share capital (and altering articles of association if power to reduce share capital is not already included) File special resolution(s) with the Registrar of Companies and reprinted memorandum and articles of association, if necessary, with Companies House. File petition and application notice with the court, together with supporting affidavits

D-23

Court-convened meeting and general meeting Present petition to court. Complete report of the chairman to court. Swear and file witness statements in support of petition and witness statements as to service of notice convening court meeting

D-22

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‘Return of capital’ demergers 25.12 Date D-19 D-12

Capital reduction Scheme of arrangement Review documents with court Directions hearing and giving of orders from court D-9 Advertise notice of the hearing of the petition in a national newspaper. Lodge newspaper at court D-4 Hearing of petition. Obtain court order D-3 Record date. File court order with Companies House. Effective date of scheme of arrangement D-1 Hearing of petition. Court order and minute stamped D File copy of minute and court order with Companies House. Effective date of reduction of capital As court Advertise registration of order directs in a national newspaper

Other legal issues to consider 25.12 Where a public company is issuing shares for non-cash consideration, company law requires that, other than where the issue falls within the exemptions in the Companies Act, such non-cash consideration is valued by an independent person. One way that a valuation can be avoided in relation to the issue of shares by the holding company to the new holding company is if shares are being issued by the first company to its members. In order that these requirements can be met, the holding company must be a member of the old holding company at the time the existing shares are cancelled and the reserve used to pay up shares to be issued to the new holding company. This is usually effected by the existing holding company issuing non-voting shares to the new holding company immediately prior to the cancellation of the current shares taking effect, thereby meaning that the new holding company following such cancellation is the only member of the old holding company.

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25.13 ‘Return of capital’ demergers

TAX ANALYSIS Examples and analyses 25.13 Let us now revisit Figure 25.2 to see how the transaction falls into the various provisions for reconstructions.

Is it a reconstruction? 25.14 As always, let us remind ourselves of the four conditions to be satisfied if the transaction is to be a reconstruction per TCGA 1992, Sch 5AA: ●●

there must be an issue of ordinary share capital by at least one transferee company to shareholders of the transferor company; and

●●

that share issue by the transferee company must be pro rata to the shareholdings of the relevant classes of share in the transferor company; and

●●

the business carried on by the transferor company must subsequently be carried on by one or more successor companies; or

●●

there must be a scheme or arrangement under CA 2006, Part 26.

In this example, the shares or assets are transferred to a new company. That new company then issues shares to the shareholders of the distributing company as a result and all the shareholders of the distributing company also receive shares in the transferee company in the same proportions. TCGA 1992, Sch 5AA – the first condition 25.15 Clearly, the transaction involves the issue of shares by the transferee company, New Co in Figure 25.2, so the first condition is satisfied. TCGA 1992, Sch 5AA – the second condition 25.16 There is nothing in the Companies Act that says that the shares must be issued pro rata by the transferee company, but, as we have surmised before, the nature of the rights of shareholders is that all holders of the same class of shares should be treated equally. So it seems likely, once again, that in the first example the issue of shares to each shareholder would necessarily be pro rata to the shareholdings in the distributing company.

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‘Return of capital’ demergers 25.19 In any case, even if company law does not require a pro rata issue of shares by the transferee company, it follows from the definition in TCGA 1992, Sch 5AA that this is required for tax purposes. Therefore, the second condition is satisfied or can be made to be satisfied by ensuring that shares are issued by New Co pro rata to the shareholdings in Top Co. TCGA 1992, Sch 5AA – the third and fourth conditions 25.17 The definition of a demerger is that the original company’s business is separated and subsequently carried on by more than one successor company. In Figure 25.2, the demerger is by transfer of a subsidiary from the transferor company, Top Co, so one of the successor companies is the original company, being Top Co, the company whose share capital was reduced, and the other is New Co. Therefore, the third condition is satisfied. Since only one of the third or fourth conditions needs to be satisfied, we do not need to look at the fourth condition. Conclusion 25.18 Overall, a demerger by reduction in capital is a reconstruction as defined by TCGA 1992, Sch 5AA. Again, matters are far more straightforward in this respect than before the introduction of that definition, when it was then necessary to rely on Statement of Practice 5/85 or the predecessor Press Release in the case of a partition demerger.

Reliefs for distributing company 25.19 At the company level, relief from the charge to corporation tax on a chargeable gain is given by TCGA 1992, s 139, whereby the transfer of Company B is deemed to be at such a consideration as to give no gain and no loss for capital gains purposes. This treatment applies to both the transferor company Top Co, which thereby has no chargeable gain, and to the transferee New Co, which thereby has a base cost equal to Top Co’s (including indexation if applicable). We have been through TCGA 1992, s 139 in detail already, but here is a reminder of its requirements: ●●

there must be a scheme of reconstruction (TCGA 1992, s 139(1)(a));

●●

there must be a transfer of all or part of the company’s business to another company (TCGA 1992, s 139(1)(a));

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25.19 ‘Return of capital’ demergers ●●

the companies must be UK tax resident or within the charge to UK corporation tax on chargeable gains (TCGA 1992, s 139(1)(b), (1A));

●●

the transferor company must not receive any consideration for the transfer (TCGA 1992, s 139(1)(c)).

We clearly satisfy the first of these requirements by virtue of being a TCGA 1992, Sch 5AA reconstruction and by satisfying the third condition of TCGA 1992, Sch 5AA, the business transfer condition, we satisfy the second requirement. Again, we will assume that the third requirement is satisfied for the purposes of our examples. The fourth requirement gives a little more difficulty. When these transactions started to become more common, around the mid-1990s, some company lawyers were concerned that the cancellation of the share capital was in some way consideration for the transfer of business to the transferee company, the argument being that because share capital sits on the liabilities side of the balance sheet, a reduction of share capital is a reduction of the company’s liabilities and is, therefore, consideration to it. There are a number of responses to this point. On a very practical level, HMRC has never suggested that this is the case. There have been enough of these transactions over the last 20 years or so that, if there were any suggestion that TCGA 1992, s 139 was prevented from applying, we would know about it by now. We also think it would be an abuse of the English language to refer to the reduction of capital of a company as being consideration. Finally, we note that the transaction involves the transfer of the business, either assets or shares, to the transferee company as consideration for the reduction of share capital, not vice versa. It is the business transfer that is consideration, not the reduction of share capital. Therefore, we are content that the fourth requirement is satisfied in a demerger by reduction of capital as no consideration is given for the reduction. Overall, once again, it is clear that the examples given above fulfil the requirements for the corporate relief given by TCGA 1992, s 139 to apply. The transfer of assets to the new companies will be on a ‘no gain no loss’ basis. Accordingly, the distributing company will not be chargeable to corporation tax on a chargeable gain and the trade and assets will be treated as having been acquired by the transferee company at the original cost and, for the purposes of indexation, at the date they were originally acquired.

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‘Return of capital’ demergers 25.21 For completeness, we would note that the substantial shareholding exemption cannot apply to the distributing company in this form of transaction. If the assets transferred are shares of a subsidiary company, ‘no gain no loss’ transactions are specifically excluded from the substantial shareholding exemption by TCGA 1992, Sch 7AC, para 6.

Reliefs for non-corporate shareholders 25.20 So far as the shareholders are concerned, this is a distribution out of assets of the company that is not an income distribution, by virtue of CTA 2010, s 1000(1)B(a). Therefore, by TCGA 1992, s 122, it is a capital distribution and we need to see whether TCGA 1992, s 136 can apply. The three primary conditions for TCGA 1992, s 136 to apply are (as always, we are assuming for all purposes that the demerger is being carried out for bona fide commercial reasons and not for the avoidance of tax): ●●

there must be an arrangement between a company and its shareholders (TCGA 1992, s 136(1)(a));

●●

this must be for the purposes of a scheme of reconstruction (TCGA 1992, s 136(1)(a));

●●

another company must issue shares to the shareholders of the first company pro rata to their shareholdings in that company, whether those original shares are retained or cancelled (TCGA 1992, s 136(1)(b)).

We would expect these demergers to be the result of an arrangement between the distributing company and its shareholders and that arrangement would always be for the purposes of the scheme of reconstruction that is the demerger and the final condition is again satisfied by virtue of satisfying the pro rata share issue requirement of the second condition of TCGA 1992, Sch 5AA. So the requirements of TCGA 1992, s 136 are clearly satisfied and the TCGA 1992, s 136 relief is available. Thus, the transaction is treated as if there has been a reorganisation of the share capital of the distributing company, which is why the result is so similar to that of the indirect demerger. The shareholders end up with shares in both the distributing company and the transferee company. Those shares are treated as if both sets of shares were acquired at the same time and for the same total price as the original shares held in the distributing company. The base cost is split between them as described in Chapter 6.

Reliefs for corporate shareholders 25.21 Corporate shareholders may benefit from the substantial shareholding exemption, rather than from the reorganisation provisions imposed by 581

25.22 ‘Return of capital’ demergers TCGA 1992, s 136, in cases where the assets demerged are shares in a subsidiary (but obviously not where the assets transferred are not shares). Again, we need to look at TCGA 1992, Sch 7AC, para 4(1)(b), which, with para 4(5), tells us to ignore the reorganisation provisions of TCGA 1992, s 127, as applied by TCGA 1992, s 136, in determining whether there is a disposal to which the substantial shareholding exemption might apply. So, again, we assume that the distribution in specie is a capital distribution to which the reorganisation provisions do not apply. We then have to look at whether the conditions relevant to the substantial shareholding exemption are satisfied. In particular, as for liquidation demergers, the major factor to consider is whether the trading conditions are satisfied for both the distributing company and the demerged company. This is obviously a matter of fact to be determined for the specific group. If the companies do not qualify for the substantial shareholding exemption, then the reorganisation provisions apply as they do for non-corporate shareholders. If the companies do qualify for the substantial shareholding exemption, that exemption takes priority and the reorganisation provisions are ignored by virtue of TCGA 1992, Sch 7AC, para 4(3)(a). So the corporate shareholder is treated as making a capital part disposal of the shareholding in the distributing company, although that part disposal is then exempt under paragraph 1 of the substantial shareholding exemption. As in previous analyses, corporate shareholders that do not qualify for the substantial shareholding exemption should get relief under TCGA 1992, s 136, as for non-corporate shareholders.

Partition demergers 25.22 The tax analysis for a partition demerger is very similar to that for the non-partition version, as demonstrated by Figure 25.3. Typically, there will be a preliminary reorganisation of the share capital of the holding company, first, into shares with rights over the appropriate parts of the business (for example, into A and B shares, where the A shares have rights over the business to be retained and the B shares have rights over the business to be demerged). The preliminary reorganisation is a normal reorganisation of share capital, to which TCGA 1992, s 127 applies, and it is also ignored for the purposes of TCGA 1992, Sch 5AA, by virtue of para 6.

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‘Return of capital’ demergers 25.22 Figure 25.3

The new top company is then inserted, and it issues shares with the same rights as those of the holding company. We would expect this step to be a scheme of reconstruction within TCGA 1992, Sch 5AA. Then the assets to be demerged are be transferred to the new top company, so the position is as shown in Figure 25.3 (left-hand side). The demerger is then carried out by way of a reduction of the capital by cancellation of the B shares, and the transferee company will issue shares to the B shareholders of Top Co pro rata to their original B shareholdings, so that the second condition of TCGA 1992, Sch 5AA is satisfied. Having established that a partition demerger by this mechanism is a reconstruction too, the analysis for the availability of relief at corporate level, under TCGA 1992, s 139, is the same as above. For A shareholders, the shareholders retaining their shares in the new holding company, the reorganisation provisions effectively have no further impact. Their base cost in the shares they hold will be the same as their base cost in the original holding company from when the new holding company was inserted, and the reduction of capital does not affect these shareholders. For the B shareholders to whom the reorganisation provisions apply, under TCGA 1992, s 136, their base cost in the new shareholding in the transferee company will be the same as their base cost in the B shares of the new holding company and this, in turn, will be the same as their base cost in the original holding company from when the new holding company was inserted. 583

25.23 ‘Return of capital’ demergers If the assets of Hold Co are investment properties, we see the scope for the prevention of a charge to SDLT, as illustrated by Figure 25.4. In a liquidation demerger, after the insertion of Top Co and the transfer of portfolio B, Top Co would be liquidated. Prop Co would be transferred to one new company and the properties in portfolio B would be transferred to another. This latter transfer would carry SDLT, which is usually of sufficient quantum that the transaction was too expensive. Figure 25.4

However, this can be avoided by using a reduction of capital demerger. After the insertion of Top Co and the transfer of portfolio B to Top Co, the capital of Top Co would be reduced by cancelling the A shares, as in Figure 25.3. Prop Co would be transferred to a new company owned by the B shareholder but the properties in portfolio A would remain within Top Co. Since there is no transfer of a chargeable interest outside the corporate group, no SDLT charge arises, yielding a substantial saving in cost terms and, indeed, making transactions economically possible that had previously been impossible. This is explained in more detail in 25.27.

Further issues on return of capital TCGA 1992, s 179 charges 25.23 A charge under TCGA 1992, s 179 may arise as a result of a reconstruction by reduction of capital if an asset has previously been transferred between group companies. The analysis is largely as described in Chapter 23 584

‘Return of capital’ demergers 25.26 but the problem is resolved by the changes to the degrouping charge in FA 2011 (see 23.15 for more detail).

Other tax issues 25.24 The other issues we have looked at such as capital allowances balancing charges and crystallising held-over gains can also arise under reduction of capital demergers, but the crucial point here is that these demergers leave the distributing company intact. So it is possible to demerge a business or subsidiary where these issues do not arise, while leaving the distributing company undisturbed so that none of these charges arises.

CONCLUSION 25.25 The reduction of capital route was the most complex, time-consuming and expensive route to carrying out a demerger, although it was still used occasionally, most notably in a number of high-profile public company demergers in the late 1990s and early 2000s, where the other mechanisms have not been available. However, the relaxation of the company law for reduction of capital in private companies means that this mechanism is becoming more popular as an alternative to liquidation demergers.

STAMP DUTY 25.26 A demerger by way of return of capital can qualify for stamp tax reconstruction reliefs in much the same way as any other demerger, and the comments in 22.13 and 22.17 relating to those reliefs and the conditions attached to them apply here too. If, as suggested at 25.8, a new holding company is to be inserted first, the transfer of shares to that new company is capable of qualifying for relief under FA 1986, s 77. However, this requires the cooperation of all shareholders, as shareholdings in the old top company must be reproduced as precisely as possible in the new company (FA 1986, s 77(3)(d)–(h)). If this cannot be achieved, stamp duty will be payable by the new company on the acquisition of the old top company. The transaction must also be carried out for commercial reasons and must not be part of a scheme or arrangement to avoid a liability to stamp duty, stamp duty reserve tax, income tax, corporation tax or capital gains tax (FA 1986, s 77(3)(c)).

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25.27 ‘Return of capital’ demergers If the acquisition proceeds by way of a court-sanctioned scheme of arrangement, this may take place with no stamp tax cost. The possible impact of the anti-avoidance provisions in FA 1986, s 77A will, of course, have to be considered carefully in cases where, as a result of the reduction of capital, control of the new holding company will change, which would be a ‘disqualifying arrangement’ for the purposes of that provision (FA 1986, s 77A(2)), such as in Figure 25.4, where Top Co is originally owned by the A and B shareholders together but, following the reduction of capital, TopCo is owned by the A shareholder only. This is a change of control to which FA 1986, s 77A would apply. However, from 22 July 2020, FA 1986, s 77A was modified so that relief under FA 1986, s 77 is available so long as the person obtaining control (eg the A shareholder in Figure 25.4) had held at least 25 per cent of the issued share capital of Prop Co for at least three years prior to the share exchange (FA 1986, s 77A(2), (2A)).

STAMP DUTY LAND TAX SDLT on transferring properties to the new holding company 25.27 When we are splitting up a property portfolio, as in Figure 25.4, we need to consider the potential for a charge to SDLT when hiving up the A properties to Top Co. There are two ‘reliefs’ to consider. Firstly, to the extent possible, we want to transfer portfolio A from Prop Co to Top Co by distribution in specie. This should not be chargeable to SDLT as there is no consideration. The normal rule that imposes a market value consideration in such cases (FA 2003, s 53) does not apply to distributions (FA 2003, s 54(3)). To the extent that we cannot use a distribution in specie – for example, where the hive up is in return for Top Co also assuming mortgage debt – we would hope to be able to rely on the SDLT group relief (FA 2003, Sch 7, Pt 1). This applies when there is a transfer of a chargeable interest within a group (FA 2003, Sch 7, para 1(1)). Companies are in the same group if one is a direct or indirect 75 per cent subsidiary of the other, or if both are 75 per cent subsidiaries of a third company (FA 2003, Sch 7, para 1(2)). For these purposes, the 75 per cent test requires a company to hold at least 75 per cent of the ordinary share capital of the other company, as well as being entitled to at least 75 per cent of the profits available for distribution to equity holders and entitled to at least 75 per cent of any assets available for distribution to equity holders on a winding up (FA 2003, Sch 7, para 1(3)). There is also an overriding requirement that group relief can only be given so long as the transaction is for bona fide commercial reasons and doesn’t 586

‘Return of capital’ demergers 25.28 form part of arrangements with a main purpose of avoiding a liability to stamp duty, income tax, corporation tax, capital gains tax or stamp duty land tax (FA 2003, Sch 7, para 2(4A)). The concern is that group relief might be denied by FA 2003, Sch 7, para 2(1), which applies if there are arrangements in existence by virtue of which ‘at that time or some later time a person has or could obtain or any persons together could have obtained control of the purchaser but not of the vendor’. In Figure 25.4, the nature of the partition demerger is that there are clearly arrangements in place whereby the control of Top Co will initially be with the A and B shareholders, jointly, but will shortly afterwards be with just the A shareholder, which would appear to trigger FA 2003, Sch 7, para 2(1). In the opinion of the authors, the situation is both uncertain and somewhat unsatisfactory, as HMRC effectively operates an unpublished concession to allow group relief to apply in such cases. To some extent, this can be seen to derive from the comments by the Economic Secretary to the Treasury during the parliamentary debates on the equivalent stamp duty provision in Finance Act 2000: ‘I am persuaded that there are commercial situations in which an asset is transferred to another group company after arrangements are in place for the transfer or company to leave the group. In a sense, therefore, the assets never leave the original group. I am willing to make a concession to such cases.’ (Hansard, 18 July 2000, col 253) HMRC’s guidance at SDLTM23015 goes on to say ‘HM Revenue and Customs will not argue that paragraph 2(1) denies group relief in cases where the transferor is to leave the group having transferred the land to other group members’. And SDLTM23040 has a ‘whitelist’ of transactions that would be considered to satisfy the commercial requirements of FA 2003, Sch 7, para 2(4A): the fourth bullet point in the guidance refers to ‘the transfer of a property to a group company prior to the sale of shares in the transferor company, in order that the property should not pass to the purchaser of the shares’. Overall, therefore, although the analysis is not entirely intellectually satisfactory, we can be comfortable that the transfer of the properties to Top Co should be free of SDLT by virtue of the group relief.

SDLT on the transfer of Prop Co 25.28 We also have to consider whether group relief is withdrawn as a result of the vendor, Prop Co in Figure 25.4, leaving the group within three years 587

25.29 ‘Return of capital’ demergers of the transfer of the chargeable interests (FA 2003, Sch 7, para 3(1)). This transfer is protected by the provisions of FA 2003, Sch 7, para 4ZA. Prima facie, FA 2003, Sch 7, para 4ZA doesn’t apply where the purchaser (Top Co) ceases to be a member of the same group as the vendor (Prop Co) just because the vendor leaves the group (FA 2003, Sch 7, para 4ZA(1)). So the main charging provision isn’t in play. However, FA 2003, Sch 7, para 4ZA(4) claws back the group relief if there is a change in the control of the purchaser after the vendor leaves the group. On a partition demerger, there is a change of control of the purchaser and the vendor leaves the group. But the sequence of events is that, firstly, the relevant shares are cancelled (the A shares in Figure 25.4), which constitutes the change of control of the new holding company, and then the vendor company leaves the group. Therefore, the change of control is before the vendor leaves the group, or potentially simultaneous with the vendor leaving the group, but the change of control cannot be after the vendor has left the group, as the vendor cannot leave the group without the shares having been cancelled. An obvious note of caution here is that, if Top Co were to be sold within three years of the hive up to Top Co, after the demerger, the original SDLT group relief might still be clawed back under FA 2003, Sch 7, paras 3(1) and 4ZA(4).

VALUE ADDED TAX Preliminary superimposition of Top Co 25.29 Often the first step will be to superimpose a new Top Co, see 25.8 above. If this is done by way of share-for-share exchange, the VAT position will be as explained in 8.24–8.28.

Treatment of the demerger itself 25.30 The VAT treatment of the parties in relation to the demerger exercise itself is as set out in Chapter 24. Where a subsidiary is demerged to ultimate shareholders direct, see 24.115–24.118. Where the distribution is of a subsidiary to a New Co, and New Co issues shares to ultimate shareholders, see 24.123–24.127. Even if the word ‘consideration’ is used in the formal documents, neither the distributing company nor New Co should be making any supply for VAT purposes: see 23.26 above.

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Chapter 26

EU cross-border demergers

INTRODUCTION 26.1 In this chapter we will look at how the UK tax regime permits cross-border demergers within the EU. This includes a review of a number of provisions enacted as a result of the EU Mergers Directive to facilitate cross-border partial divisions. As has already been stated earlier in this book, this chapter must, of course, be read subject to any on-going developments in the tax legislation in the UK as a result of the UK leaving the EU on 31 January 2020, though still subject to possible amendment before the IP completion date, currently scheduled for 11pm on 31 December 2020. The future status of all EU Regulations, Directives and case law in relation to UK law will entirely depend on the terms under which the UK ultimately leaves the EU and how domestic statute evolves over time. Domestic legislation enacted under the influence of EU law will remain in force, but will be subject to amendment by the UK Parliament. For the moment, however, UK company law must comply with the TFEU1. That is, UK domestic legislation is required to comply with the fundamental freedoms of the TFEU, and provisions that permit transactions within the UK only may contravene the freedoms of establishment and movement of capital. So, we need to look at both UK company law and UK tax law and consider whether all UK domestic demergers can be carried out in an EU cross-border context, too. First, until Directive (EU) 2019/2121 on cross-border conversions came into force, there was no standardised company law regime for cross-border divisions across Europe. Member States have three years to implement this Directive. Whether the UK will do so is currently unknown. Second, UK tax legislation must also comply with the Mergers Directive2, which is EU tax legislation, as explained in Chapter 4. So, here we also need to explore whether the UK’s tax legislation permits the transactions that the Mergers Directive requires. This involves looking at UK legislation from the opposite direction. That is, in terms of the TFEU we are asking whether a UK 589

26.2 EU cross-border demergers domestic transaction can be replicated in an EU cross-border environment, thus not being discriminatory. When we look at the Mergers Directive, we are asking whether the UK permits the form of transaction that the Directive requires. These may be partly overlapping points, as they are both generally concerned with reducing barriers within the EU and creating the single market. However, they are very different questions, so we will look at the various types of demerger that we have identified in Chapters 23, 24 and 25 to see how they comply with the TFEU, as well as asking whether they are also of a form required by the Mergers Directive to be ‘divisions’ or ‘partial divisions’. We will then, where necessary, look at the Mergers Directive to ensure that UK domestic legislation permits ‘divisions’ and ‘partial divisions’. Other than relatively minor amendments to cross-references to other legislation, there have been no material changes to these provisions since 2007. The Taxes (Amendments) (EU Exit) Regulations 2019 (SI 2019/689) have made some prospective amendments to TCGA 1992, ss 140A–140L to allow these provisions to apply in circumstances when the UK is no longer an EU Member State from the relevant ‘exit day’. This has been included in the commentary below where relevant. But first, what is the legislative framework?

1 Treaty for the Functioning of the European Union. 2 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005).

LEGISLATIVE BACKGROUND UK company law 26.2 There has not been any new enabling company legislation (equivalent to the Company Law Directive on Cross-Border Mergers) that requires the UK to make provision for cross-border divisions by dissolution without liquidation. Now that the UK has left the EU, it seems unlikely that it will implement legislation equivalent to that set out in the Cross-Border Conversion Directive, although this is dependent on the terms of the trade relationship to be negotiated with the EU. Arguably, of course, this is not necessary. In most cases, we are looking at transactions where a UK company is parting with assets – either as a distribution in specie, in a liquidation or by reduction of capital – and the governing company law is already in place. UK company 590

EU cross-border demergers 26.5 law does not need to concern itself with a transferee company that is not a UK company. So, there should be no need for specific legislation just because one or more of the transferee companies in a demerger are resident in other Member States.

UK tax law 26.3 As we have already seen, the legislation regarding demergers by distribution in specie contains provisions that are intended to be compliant with EU legislation, ie the basic freedoms of the TFEU and the Mergers Directive. CTA 2010, s 1081(1) allows demergers within CTA 2010, ss 1076 and 1077 to be exempt distributions, as long as the relevant companies are all resident in a Member State. There is a prospective amendment to this provision introduced by the Taxes (Amendments) (EU Exit) (No 2) Regulations 2019 (SI 2019/818) which take into account the effect of Brexit from the ‘exit day’. CTA 2010, s 1078 is specifically intended to comply with the Mergers Directive in permitting cross-border demergers that are what the Directive refers to as ‘partial divisions’. As we shall see later in this chapter, the UK has implemented the Mergers Directive requirements for partial divisions into TCGA 1992, ss 140A–140D.

The Mergers Directive – divisions and partial divisions 26.4 Before we move on to consider the UK’s tax legislation, we should remind ourselves of the transactions described by the Mergers Directive. This refers to two types of business division, a division and a partial division.

Division 26.5

A division is defined as:

‘an operation whereby a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to two or more existing or new companies, in exchange for the pro rata issue to its shareholders of securities representing the capital of the companies receiving the assets and liabilities, and, if applicable, a cash payment not exceeding 10% of the nominal value or, in the absence of a nominal value, of the accounting par value of those securities.’ A typical division would look like Figure 26.1. This is structurally similar to a demerger by liquidation, although the definition of a division requires the transferor company to be dissolved without going into liquidation. 591

26.6 EU cross-border demergers Figure 26.1 Mergers Directive ‘division’

Partial division 26.6

Partial division is defined as:

‘an operation whereby a company transfers, without being dissolved, one or more branches of activity, to one or more existing or new companies, leaving at least one branch of activity in the transferring company, in exchange for the pro-rata issue to its shareholders of securities representing the capital of the companies receiving the assets and liabilities, and, if applicable, a cash payment not exceeding 10% of the nominal value or, in the absence of a nominal value, of the accounting par value of those securities.’ A typical partial division would look like Figure 26.2, and is structurally similar to a demerger by distribution in specie or by return of capital. Figure 26.2 Mergers Directive ‘partial division’

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EU cross-border demergers 26.9

EU CROSS-BORDER DEMERGER TRANSACTIONS 26.7 Here we are going to look at each type of UK demerger and see how they fit (or don’t fit) into the EU legislative framework.

Liquidation demergers 26.8 Let us look at some scenarios for cross-border demergers by liquidation and see how the UK’s tax legislation complies with EU requirements.

Compliance with the TFEU 26.9 In our first example (Figure 26.3), a UK company is liquidated. All its activities are in the UK but some of those activities are transferred to a French company that will begin to carry them on. Figure 26.3 Cross-border demerger by liquidation

In terms of the TFEU and the fundamental freedoms, we need to ask three questions: (a)

Is the transaction potentially a scheme of reconstruction?

We would say that it is, for the same reasons as discussed in Chapter 23. In particular, the definition of a scheme of reconstruction, in TCGA 1992, Sch 5AA, does not refer to the residence of the companies involved in a scheme of reconstruction. So, there is no requirement that the transferee companies be UK resident.

(b) Can TCGA 1992, s 136 apply to the shareholders?

Again, we believe it can for the reasons given in Chapter 23, as TCGA 1992, s 136 makes no reference to the residence of the companies (or of the residence of the shareholders, for that matter).

(c) Can TCGA 1992, s 139, which would provide relief for the disposals by the transferor company, apply? 593

26.9 EU cross-border demergers The legislation either requires the successor companies to be UK resident or it applies if the assets transferred to the successor company remain within the UK tax net by virtue of TCGA 1992, s 2B(3) (non-resident company with UK permanent establishment). In this case, the UK activities held by the French company should constitute a UK permanent establishment of that company, if they are trading activities (TCGA 1992, s 2C). This would comply with the requirements of TCGA 1992, s 139(1A), so the reconstruction relief would be available to the company. If the activities in the UK are not trading activities, or do not amount to a permanent establishment of the French company, then there is a problem with the application of TCGA 1992, s 139 here, as the requirement at TCGA 1992, s 139(1A)(a), that the assets be chargeable assets of the transferee company, is not satisfied. So, in the absence of trading activities this form of cross-border demerger does not appear to qualify for the reliefs that would be available were both transferees UK resident companies, which would prima facie contravene the fundamental freedoms of the TFEU. In our second example (Figure 26.4), the UK company has two activities, one in Germany and the other in the UK. On liquidation, the UK business is transferred to a new UK company and the German activity is transferred to a German company. Figure 26.4 Cross-border merger by liquidation

Once again, while the transaction can be a scheme of reconstruction as defined by TCGA 1992, Sch 5AA, and TCGA 1992, s 136 can apply for the benefit of the shareholders, we have a problem with the application of TCGA 1992, s 139, as far as the original company is concerned. The German business is not a UK trade and the German company is obviously not a UK resident company. Once again, the requirement at TCGA 1992, s 139(1A)(a) is not satisfied and this form of liquidation demerger would prima facie contravene the fundamental freedoms of the TFEU.

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EU cross-border demergers 26.12

Application to the Mergers Directive 26.10 As regards the Mergers Directive, it is obvious from the structure of a liquidation demerger that it can never be a partial division, as a partial division requires that the transferor company remain in existence. Furthermore, as already noted, a liquidation demerger also cannot comply with the requirement that the transferor company be dissolved without going into liquidation. So, we conclude that a liquidation demerger is neither a division nor a partial division for the purposes of the Mergers Directive.

Demergers by distribution in specie 26.11 Let us look at the mechanisms in CTA 2010, ss 1076 and 1077. We will look at TCGA 1992, s 1078 in the context of the Mergers Directive legislation. TCGA 1992, s 1076 – transfer of shares in subsidiaries to members 26.12 ‘A distribution is an exempt distribution if– (a) it consists of the transfer by a company to all or any of its members of shares in one or more companies which are its 75% subsidiaries, (b) each of conditions A to F in sections 1081 and 1082 is met in respect of the distribution, and (c)

if the company making the transfer is a 75% subsidiary of another company, conditions L and M in section 1085 are met in respect of the distribution.’

An example might look like Figure 26.5, whereby a UK company distributes its Spanish subsidiary directly to shareholders. Figure 26.5 Direct distribution in specie

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26.13 EU cross-border demergers

Compliance with the TFEU 26.13 As far as the non-discrimination requirements of the TFEU are concerned, this is a straightforward case: ●●

Condition A of CTA 2010, s 1081 is satisfied because both relevant companies are resident in Member States.

●●

None of the other conditions in CTA 2010, ss 1081 and 1082 have any requirements regarding residence of the companies.

●●

This transaction is not a scheme of reconstruction, as previously analysed in Chapter 24, so none of the provisions of TCGA 1992, ss 136 and 139 are in point.

●●

TCGA 1992, s 192(2)(b), which requires the transaction to be treated as a reorganisation of share capital, also has no requirements regarding residence of the companies.

So, we conclude that a cross-border merger by direct distribution is permitted by UK domestic legislation, giving a position that is compliant with the TFEU.

Application to the Mergers Directive 26.14 A direct demerger of this type cannot be a division, as the distributing company continues to exist, so is not dissolved without going into liquidation. Furthermore, this is not a partial division, as the subsidiary is not transferred to another company. And even if it were (ie if there were a corporate shareholder), the transferee does not issue shares to the shareholders of the distributing company. Indeed, they cannot do so as that would be an issue of shares to themselves. So, we conclude that a cross-border direct demerger is not a Mergers Directive division or partial division. CTA 2010, s 1077(1)(a)(i) – transfer by distributing company of a trade and issue of shares by transferee company 26.15 ‘(1) This section applies to a distribution which consists of both of the following– (a) the transfer by a company to one or more other companies (“the transferee company or companies”) of– (i)

a trade or trades, … 596

EU cross-border demergers 26.17 (b) the issue of shares by the transferee company or companies to all or any of the members of the company making the transfer.’ Analysis 26.16 An example might look like Figure 26.6, whereby a UK company distributes its Polish trade to a new Polish company that issues shares to the shareholders of the UK company (ie an indirect distribution of the Polish trade). Figure 26.6 Indirect distribution in specie of a trade

Compliance with the TFEU 26.17 As far as the non-discrimination requirements of the TFEU are concerned, Condition A of CTA 2010, s 1081 is satisfied because both companies, the only relevant companies for this purpose, are resident in Member States. And, again, none of the other conditions in CTA 2010, ss 1081 and 1082 have any requirements regarding residence of the companies. This transaction is a scheme of reconstruction, however, as previously analysed in Chapter 24. The shareholder relief under TCGA 1992, s 136 should be available, as there are no residence requirements in TCGA 1992, s 136. But TCGA 1992, s 139 would be a problem, for the same reasons as for the liquidation demerger at Figure 26.4, because the requirements of TCGA 1992, s 139(1A)(a) are not met, ie the Polish company is not UK resident and the Polish trade is not a UK trading permanent establishment. So, we initially conclude that a cross-border merger by indirect distribution of a trade is not permitted by UK domestic legislation, giving a position that is not compliant with the TFEU. What happens if, instead, the distributing company had two UK trades, one of which was distributed to a new Polish company? In that case, the trade would 597

26.18 EU cross-border demergers probably be a UK trading permanent establishment of the Polish company, TCGA 1992, s 2B(3) would apply and so, therefore, would TCGA 1992, s 139(1A)(a) and the UK reconstruction relief would be available.

Application to the Mergers Directive 26.18 As regards the Mergers Directive, it is obvious from the structure of an indirect exempt distribution demerger of a trade that it can never be a division, as the transferor company remains in existence, so is not dissolved without going into liquidation. However, this is probably a partial division, as the trade is transferred to another (Polish) company which then issues shares to the shareholders of the distributing company. Furthermore, it may well be that this transaction also falls within CTA 2010, s 1078, which was enacted specifically to comply with the Mergers Directive on partial divisions. If it is compliant with the Mergers Directive, it becomes irrelevant that it might not be compliant with the TFEU, as both are directed at the single market. So, let us return to this point when we discuss CTA 2010, s 1078. CTA 2010, s 1077 – transfer by distributing company of a subsidiary and issue of shares by transferee company 26.19 ‘(1) This section applies to a distribution which consists of both of the following– (a) the transfer by a company to one or more other companies (“the transferee company or companies”) of–

… (ii) shares in one or more companies which are 75% subsidiaries of the company making the transfer, and

(b) the issue of shares by the transferee company or companies to all or any of the members of the company making the transfer.’ Analysis 26.20 An example might look like Figure 26.7, whereby a UK company distributes a Dutch trading subsidiary to a new Dutch company that issues shares to the shareholders of the UK company.

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EU cross-border demergers 26.22 Figure 26.7 Indirect distribution in specie of a subsidiary

Compliance with the TFEU 26.21 Again, as far as the non-discrimination requirements of the TFEU are concerned, Condition A of CTA 2010, s 1081 is satisfied because all three relevant companies, the UK distributing company and the Dutch companies, are resident in Member States. And, again, none of the other conditions in CTA 2010, ss 1081 and 1082 have any requirements regarding residence of the companies. And, again, this transaction is a scheme of reconstruction, as previously analysed in Chapter 24. The shareholder relief under TCGA 1992, s 136 should be available, as there are no residence requirements in TCGA 1992, s 136. But TCGA 1992, s 139 would still be a problem, because the new Dutch company is not UK resident (and the shares of the Dutch trading subsidiary are, prima facie, unlikely to be assets of a trading permanent establishment in the UK). So, we conclude that a cross-border merger by indirect distribution of a subsidiary is not permitted by UK domestic legislation, giving a position that is not compliant with the TFEU. It also seems unlikely that this transaction falls within CTA 2010, s 1078. If, instead, the distributing company had two UK subsidiaries, one of which was distributed to a new Dutch company (analogous to the alternative example of the trade demerger, above), the shares in the UK trading subsidiary are, as already noted, unlikely to be assets of a trading permanent establishment in the UK. So, the UK reconstruction relief would still not be available.

Application to the Mergers Directive 26.22 Once again, it is obvious from the structure of an indirect exempt distribution demerger of a subsidiary that it can never be a division, as the

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26.23 EU cross-border demergers transferor company remains in existence, so is not dissolved without going into liquidation. However, this is also not a partial division, as we have already discussed the fact that a partial division requires the transfer of the activities, not of subsidiary companies.

Demergers by reduction of capital 26.23 The third mechanism for a demerger is the reduction of capital route, discussed in Chapter 25.

Compliance with the TFEU 26.24 In our first example (Figure 26.8(a)), a UK company has all its activities in the UK. On reducing its capital, some of those activities are transferred to a French company that will begin to carry them on. Figure 26.8(a) Cross-border reduction of capital demerger

For the same reasons discussed in Chapter 25, and in the previous examples, it seems probable that this would be a scheme of reconstruction and that TCGA 1992, s 136 can apply to the shareholders. As regards TCGA 1992, s 139, the legislation either requires the successor companies to be UK resident or it applies if the assets transferred to the successor company remain within the UK tax net by virtue of TCGA 1992, s 2B(3) (non-resident company with UK permanent establishment). In this case, the UK activities held by the French company should constitute a UK permanent establishment of that company, if they are trading activities (TCGA 1992, s 2C). This would comply with the requirements of TCGA 1992, s 139(1A), so the reconstruction relief would be available to the company.

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EU cross-border demergers 26.25 If the activities in the UK are not trading activities, or do not amount to a permanent establishment of the French company, then there is a problem with the application of TCGA 1992, s 139 here, as the requirement at TCGA 1992, s 139(1A)(a), that the assets be chargeable assets of the transferee company, is not satisfied. So, in the absence of trading activities this form of cross-border demerger also does not appear to qualify for the reliefs that would be available were both transferees UK resident companies, which would prima facie contravene the fundamental freedoms of the TFEU. In our second example (Figure 26.8(b)), the UK company has two activities, one in Germany and the other in the UK. On reducing its capital, the German activity is transferred to a new German company. Figure 26.8(b) Cross-border reduction of capital demerger

Once again, while the transaction can be a scheme of reconstruction as defined by TCGA 1992, Sch 5AA, and TCGA 1992, s 136 can apply for the benefit of the shareholders, we have a problem with the application of TCGA 1992, s 139, as far as the original company is concerned. The German business is not a UK trade and the German company is obviously not a UK resident company. Once again, the requirement at TCGA 1992, s 139(1A)(a) is not satisfied and this form of liquidation demerger would prima facie contravene the fundamental freedoms of the TFEU.

Application to the Mergers Directive 26.25 As regards the Mergers Directive, it is obvious from the structure of a reduction of capital demerger that it can never be a division, as the transferor company remains in existence, so is not dissolved without going into liquidation. However, this is likely to be a partial division, as the subsidiary is transferred to another company which then issues shares to the shareholders of the distributing company.

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26.26 EU cross-border demergers So, we conclude that a reduction of capital demerger is capable of being a partial division for the purposes of the Mergers Directive. As we shall, see, this means that the reliefs available under TCGA 1992, ss 140A(1A) and 140B(1A) should apply to reduction of capital demergers.

Conclusions for demerger mechanisms 26.26 The main conclusion is that the UK mechanisms for relief for demergers that are schemes of reconstruction are unlikely to apply to EU crossborder demergers, where the activity that is demerged is not a trade carried on in the UK, or where the subsidiary that is demerged is not carrying on a trade in the UK, unless the activity that is demerged constitutes a UK trading permanent establishment of the transferee company1. This result is probably in contravention of the freedoms of establishment and movement of capital guaranteed under the TFEU. Indeed, it may be that the UK’s reconstruction relief in TCGA 1992, s 139 should therefore be interpreted as if it were compliant with the TFEU (see, in this context, the earlier discussion of the UK’s CFC rules in the Vodafone 2 case in Chapter 4). None of the mechanisms are divisions, for the purposes of the Mergers Directive, although a liquidation demerger involving as transfer of a business is structurally and economically almost the same. Demerger mechanisms where a subsidiary is transferred are also not partial divisions, but mechanisms involving the transfer of a business, such as described by CTA 2010, s 1077(1)(a)(i), and reduction of capital demergers are capable of being partial divisions.

1 Note that, in many of the examples shown, if the UK activity or subsidiary were demerged, rather than the non-UK activity or subsidiary, there would not be a problem, as TCGA 1992, s 139 is only prescriptive as to the residence of the activity or subsidiary that is transferred.

SPECIFIC LEGISLATION FOR THE MERGERS DIRECTIVE 26.27 The provisions referred to are CTA 2010, s 1078 and TCGA 1992, ss 140A(1A)–(1D) and 140C(1A)–(1D). There are also shareholder level protections built in by TCGA 1992, s 140DA. To allow these provisions to operate in a post-Brexit environment, prospective amendments have been introduced by SI 2019/689 and SI 2019/818 from the relevant ‘exit day’ (being the day of Brexit).

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EU cross-border demergers 26.29 CTA 2010, s 1078 – division of business in a cross-border transfer 26.28 ‘(1) This section applies to a distribution which consists of– (a) the transfer of part of a business by a company to one or more other companies (“the transferee company or companies”), and (b) the issue of shares by the transferee company or companies to the members of the company making the transfer. (2) A distribution to which this section applies is an exempt distribution if either– (a) each of the tests in paragraphs (a) to (f) of section 140A(1A) of TCGA 1992 (cross-border transfers: division of UK business) is met in relation to it, or (b) each of the tests in paragraphs (a) to (e) of section 140C(1A) of TCGA 1992 (cross-border transfers: division of non-UK business) is met in relation to it.’ Analysis 26.29 The first point we note is that the reference in CTA 2010, s 1078 is to a business, not to a trade, so it is clearly less restrictive than the rest of the exempt distributions legislation (but see the comments below about the effect of TCGA 1992, s 140A(2)). This is because the Mergers Directive does not refer to trades, only to activities. So, any legislation intended to conform to the requirements of the Directive cannot be restricted to trades. It remains an open question, of course, whether a business is still a more restrictive concept than an activity. Then we must ask what a business is. In the context of a transaction such as that in Figure 26.6, the transfer of one of the trades of the UK company would clearly be a transfer of part of that company’s business. But what about the transfer of a subsidiary, as in Figure 26.7? The authors believe that the correct view is that the holding of subsidiaries is not intended to be interpreted as a ‘business’ of the UK company. This is admittedly inconsistent with the interpretation of the word ‘business’ in TCGA 1992, s 139(1), as discussed at 18.18. But the word ‘business’ is only used in TCGA 1992, ss 140A and 140C to comply with the Mergers Directive, rather than to widen the meaning of the word to include holding shares. Even if one were to take the view that ‘business’ here includes the holding of shares, this

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26.30 EU cross-border demergers doesn’t fit comfortably with the scheme of TCGA 1992, s 140A, particularly TCGA 1992, s 140A(1A)(b), discussed in detail below. CTA 2010, s 1078(1)(b), the requirement for an issue of shares by the transferee company to the shareholders of the transferor company, is compliant with the requirement of the Mergers Directive for partial divisions. In fact, the Directive requires a pro rata issue of shares, which is more restrictive than the UK legislation here. It is also important to note that a demerger under CTA 2010, s 1078 is not required to satisfy any of the conditions in CTA 2010, ss 1081–1085. Instead, it has to satisfy the conditions of TCGA 1992, s 140A(1A) or 140C(1A). Let us now turn to TCGA 1992, ss 140A(1A) and 140C(1A) to see what transactions of partial division CTA 2010, s 1078 might look like and how the EU reliefs apply.

TCGA 1992, s 140A – transfer or division of UK business TCGA 1992, s 140A(1) – qualifying conditions 26.30 This provision is relevant to transfers of assets and branch incorporations, covered in Chapter 28. TCGA 1992, s 140A(1A) to (1D) – partial divisions 26.31 ‘(1A) This section also applies where a company transfers part of its business to one or more companies if – (a) the transferor is resident in one Member State, (b) the part of the transferor’s business which is to be transferred is carried on by the transferor in the United Kingdom, (c)

at least one transferee is resident in a Member State other than that in which the transferor is resident,

(d) the transferor company continues to carry on a business after the transfer, (e)

the conditions in subsection (1)(c) to (e) are satisfied (for which purpose references to the transferee shall be taken as references to each of the transferees), and

(f)

either of the following conditions is satisfied

604

EU cross-border demergers 26.32 (1B) Condition 1 is that the transfer is made in exchange for the issue of shares in or debentures of each transferee company to the persons holding shares in or debentures of the transferor. (1C) Condition 2 is that the transfer is not made in exchange for the issue of shares in or debentures of each transferee by reason only, and to the extent only, that a transferee is prevented from complying with Condition 1 by section 658 of the Companies Act 2006 (rule against limited company acquiring own shares) or by a corresponding provision of the law of another Member State preventing the issue of shares or debentures to itself. (1D) If Condition 2 applies in relation to the whole or part of a transfer, sections 24 and 122 do not apply in relation to the transfer.’ Analysis 26.32 This provision is intended to permit cross-border partial divisions (or demergers), as defined by the Mergers Directive. For the relief to apply, we need a transferor with a business in the UK transferring that business to a transferee in another Member State. The transferee can therefore be a UK resident company or a non-UK company with a UK business. Remember, the main beneficiaries of the exempt distributions provisions are the shareholders of the distributing company, who are not treated as receiving income distributions, so it doesn’t matter here if the distributing company is UK resident or not. An important point here is TCGA 1992, s 140A(1A)(b), requiring that ‘the part of the transferor’s business which is to be transferred is carried on by the transferor in the United Kingdom’. It is easy to see how a trade or wider business can be carried on in the UK. It is less clear whether the phrase could include the holding of shares of subsidiaries. That is, how does one carry on the business of holding shares in the UK? This conceptual difficulty is part of the argument that leads us to conclude that CTA 2010, s 1078 is not easily applicable to transfers of shareholdings. To allow TCGA 1992, s 140A to operate in a post-Brexit environment, the words ‘Member State’ have been replaced with ‘relevant state’. This is defined as the UK or an EU Member State and has been introduced by SI 2019/689 from the ‘exit day’ (being the day of Brexit) to allow this provision to continue to apply as before. The effect of this amendment is to prevent TCGA 1992, s 140A from being broadened to apply to demergers with companies outside the EU. The transferor must continue to carry on a business after the demerger, so this provision cannot apply to divisions, only to partial divisions.

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26.32 EU cross-border demergers The conditions in TCGA 1992, s 140A(1)(c)–(e) must be satisfied in respect of the transaction. That is, the relief must be claimed by both transferor and transferee companies, the relief is subject to the anti-avoidance provisions of TCGA 1992, s 140B and the transferee must satisfy one of the ‘appropriate conditions’ in TCGA 1992, s 140A(2) or (3) (see below). A partial division must also satisfy one of the 2 conditions at TCGA 1992, s 140A(1B) or (1C). Condition 1 requires the transferee company to issue shares or securities to the shareholders of the transferor company. There is no leeway here to permit any cash consideration, so this provision may not be fully compliant with the Directive, which permits up to 10 per cent of the consideration to be in cash. It also doesn’t require the issue of shares to be pro rata to the shareholding in the distributing company, although this might be implicit in normal shareholders’ rights. Condition 2 suspends the requirement for a share issue where the transferee is a company that is a shareholder in the transferor. In such a case, the requirement for the transferee company to issue shares to the transferor’s shareholders would mean the transferee issuing shares to itself, which is not lawful in the UK. So, condition 2 is satisfied if this is the only reason that the transferee does not issue shares to the shareholder of the transferor. Finally, in cases where there is no share issue and Condition 2 applies, TCGA 1992, ss 24 (loss of asset) and 122 (capital distributions) do not apply. To impose a chargeable gain by the operation of either of these provisions would clearly be inappropriate when this legislation is designed as a relief from tax for partial divisions. So, for the purposes of the application of TCGA 1992, s 140A(1A), a transaction permitted under CTA 2010, s 1078 might look like Figure 26.9, where a UK company transfers part of its UK business to a new Belgian company. Figure 26.9 CTA 2010, s 1078 and TCGA 1992, s 140A

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EU cross-border demergers 26.34 Another version might look like Figure 26.10, where a Danish company transfers a UK business to a new UK company. Figure 26.10 CTA 2010, s 1078 and TCGA 1992, s 140A

As discussed above, we also believe that TCGA 1992, s 140A(1A) can apply to a reduction of capital demerger, as the legislation does not require the transfer to have been carried out by way of distribution. TCGA 1992, s 140A(2) and (3) – ‘the appropriate conditions’ for transferee 26.33 ‘(2) Where immediately after the time of the transfer the transferee (or each of the transferees) is not resident in the United Kingdom, the appropriate condition is that were it to dispose of the assets included in the transfer any chargeable gains accruing to it on the disposal would form part of its chargeable profits for corporation tax purposes by virtue of section 2B(3). (3) Where immediately after the time of the transfer the transferee (or each of the transferees) is resident in the United Kingdom, the appropriate condition is that none of the assets included in the transfer is one in respect of which, by virtue of the asset being of a description specified in double taxation relief arrangements, the company falls to be regarded for the purposes of the arrangements as not liable in the United Kingdom to tax on gains accruing to it on a disposal.’ Analysis 26.34 TCGA 1992, s 140A(2) explains the appropriate condition for relief under TCGA 1992, s 140A(1A) if the transferee company is not UK resident. The condition is that the business must be a UK trading permanent establishment of

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26.35 EU cross-border demergers the transferee company (inferred from the reference to TCGA 1992, s 2B(3)), so that any disposal of the assets of the business will be within the scope of UK corporation tax on chargeable gains. The policy behind this condition is that the disposal of the assets is not intended to escape UK corporation tax on any chargeable gain that might accrue on eventual disposal. The interesting point about TCGA 1992, s 2B(3), however, is that it applies only where a company is carrying on a trade through a permanent establishment as a result of TCGA 1992, s 2C(1). So, despite the reference in CTA 2010, s 1078 to a transfer of part of a business, where the transferee is not UK resident, the legislation is still restricted to trades carried on in the UK. This is more restrictive than the requirement for UK resident companies, in TCGA 1992, s 140A(3), which suggests that the UK’s legislation is not as compliant with the Mergers Directive as it should be. Furthermore, TCGA 1992, s 140A(2) would be a problem where the assets transferred are shares, as shares in subsidiaries are unlikely to constitute a trading permanent establishment (as already discussed in the context of the application of TCGA 1992, s 139(1A)(a) to cross-border demergers). Once again, we infer from this that the meaning of ‘business’ in CTA 2010, s 1078 is not intended to refer to the holding of shares. TCGA 1992, s 140A(3) explains the appropriate condition if the transferee company is UK resident. This is that the assets must not be assets that are precluded from UK taxation on disposal by any double tax arrangements. Again, the policy behind this condition is that the company must be subject to UK corporation tax on any chargeable gain that might accrue on disposal of the assets concerned. So, the relief is a deferral of tax until the assets are sold by the transferee company, not a permanent exemption. As already noted, this provision means that a UK resident transferee can satisfy TCGA 1992, s 140A(1A) even if the business does not amount to a trade, so the position of a UK resident transferee is favoured over that of a non-UK transferee. TCGA 1992, s 140A(4) – mechanism of relief 26.35 ‘(4) Where this section applies – (a) the transferor and the transferee (or each of the transferees) shall be treated, so far as relates to corporation tax on chargeable gains, as if any assets included in the transfer were acquired by the transferee (or each of the transferees) from the transferor for a consideration of such amount as would secure that on the disposal 608

EU cross-border demergers 26.37 by way of transfer neither a gain nor a loss would accrue to the transferor; (b) section 25(3) shall not apply to any such assets by reason of the transfer (if it would apply apart from this paragraph).’ Analysis 26.36 The relief operates by treating the transfer to the transferee company as being a ‘no gain no loss’ transfer, so that just like TCGA 1992, s 139, the transfer is deemed to be at a consideration such that no gain or loss would accrue to the transferor. In most cases, this will be a consideration equal to the original cost of the asset plus appropriate indexation allowance (though noting that indexation allowance was repealed with effect from 31 December 2017). It is noteworthy that the legislation makes no specific provision for the base cost of the shares issued by the transferee company. We assume these shares will be treated as having been issued at market value and this would usually be deemed to be the case for UK tax purposes in a related parties context by virtue of TCGA 1992, ss 17 and 18. TCGA 1992, s 25(3) applies where a non-UK resident person ceases to use an asset in its UK trade, and provides for a deemed market value disposal and reacquisition. This must be disapplied in the case of an EU company demerging its UK PE, as otherwise the TCGA 1992, s 140A relief would be meaningless. TCGA 1992, s 140B – anti-avoidance 26.37 ‘(1) Section 140A shall not apply unless the transfer of the business or part is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to income tax, corporation tax or capital gains tax. (2) Subsection (1) above shall not apply where, before the transfer, the Board have on the application of the transferor and the transferee (or each of the transferees) notified those companies that the Board are satisfied that the transfer will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as are mentioned in that subsection. (3) Subsections (2) to (5) of section 138 shall have effect in relation to subsection (2) above as they have effect in relation to subsection (1) of that section.’

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26.38 EU cross-border demergers Analysis 26.38 This is a straightforward anti-avoidance provision with tests and clearance rules with which most readers will be familiar. Essentially, our old friends the tests for bona fide commercial reasons and for tax avoidance motives are applied to TCGA 1992, s 140A, but to give certainty to taxpayers, a clearance is available from HMRC. This is governed by TCGA 1992, s 138 which was discussed in detail earlier in the book. One caveat is that, as always, the clearance only confirms the HMRC view that the transaction satisfies the tests relating to bona fide commercial reasons and to tax avoidance motives. The clearance will not confirm that the transaction otherwise complies with the detailed provisions of TCGA 1992, s 140A. So, for example, if there is any doubt as to whether the activities in the UK amount to a trade, the taxpayer should seek comfort by carefully analysing the tests set out in statute and case law, seeking the assistance of advisers as appropriate, but with no confirmation or blessing to be expected from HMRC.

TCGA 1992, s 140C – transfer or division of a non-UK trade TCGA 1992, s 140C(1) – qualifying conditions 26.39 This provision is relevant to transfers of assets and branch incorporations, covered in Chapter 28. TCGA 1992, s 140C(1A) to (1C) – partial divisions 26.40 ‘(1A) This section also applies where a company resident in the United Kingdom transfers part of its business to one or more companies if – (a) the part of the transferor’s business which is to be transferred is carried on, immediately before the time of the transfer, by the transferor in a Member State other than the United Kingdom through a permanent establishment, (b) at least one transferee is resident in a Member State other than the United Kingdom, (c)

the transferor company continues to carry on a business after the transfer,

(d) the conditions in subsection (1)(b), (d), (e) and (f) are satisfied, and (e)

either of the following conditions is satisfied.

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EU cross-border demergers 26.41 (1B) Condition 1 is that the transfer is made in exchange for the issue of shares in or debentures of each transferee company to the persons holding shares in or debentures of the transferor. (1C) Condition 2 is that the transfer is not made in exchange for the issue of shares in or debentures of each transferee by reason only, and to the extent only, that a transferee is prevented from complying with Condition 1 by section 658 of the Companies Act 2006 (rule against limited company acquiring own shares) or by a corresponding provision of the law of another Member State preventing the issue of shares or debentures to itself.’ Analysis 26.41 In this version of a partial division, the transferor must be a UK resident company transferring a non-UK business to one or more transferee companies, at least one of which must be resident in another Member State (ie not the UK). It is necessary to understand what the ‘business’ is in practice and whether this has been adequately reflected by the relevant legal documentation. Given the cross-border nature of this type of demerger, it will be necessary to ensure that the transfer is documented and effected to meet the requirements of the relevant tax and corporate law requirements in the UK and each relevant jurisdiction (being the jurisdiction in which the transferee is resident and the jurisdiction in which the permanent establishment is located, if these are different). An example of where there can be a potential disconnect is where there is a local requirement to have a Local Transfer Agreement for certain assets, whilst the wider transaction is documented under a broader Business Transfer Agreement. In these circumstances, it will be necessary to ensure that the combination of these agreements constitutes a single arrangement to transfer the relevant business, rather than a set of stand-alone agreements to transfer separate baskets of assets. To allow TCGA 1992, s 140C to operate in a post-Brexit environment, the word ‘a’ has been replaced with ‘another’, and the words ‘other than the United Kingdom’ have been repealed by SI 2019/689 from the ‘exit day’ (being the day of Brexit) to allow this provision to continue to apply as before. The effect of this amendment is to prevent TCGA 1992, s 140C from being broadened to apply to transfers to companies outside the EU. Again, TCGA 1992, s 140C(1A) does not to apply to a division, as it requires the transferor to continue to carry on a business.

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26.41 EU cross-border demergers As for TCGA 1992, s 140C(1), the relief must be claimed by the transferor, so the UK corporation tax provisions relating to claims will apply to TCGA 1992, s 140C and the relief is subject to the anti-avoidance provisions of TCGA 1992, s 140D. And the transferee(s) must satisfy one of the appropriate conditions in TCGA 1992, s 140C(1B) or (1C). Condition 1 requires the transferee company to issue shares or securities to the shareholders of the transferor company. There is no leeway here to permit any cash consideration, so this provision may not be fully compliant with the Directive, which permits up to 10 per cent of the consideration to be in cash. And, again, there is no specific requirement for the issue to be pro rata. Condition 2 suspends the requirement for a share issue where this would be unlawful, as described for TCGA 1992, s 140A(1A), above. And, again, in cases where there is no share issue and Condition 2 applies, TCGA 1992, ss 24 (loss of asset) and 122 (capital distributions) do not apply, for the same reasons as noted above. So, for the purposes of the application of TCGA 1992, s 140C(1A), a transaction permitted under CTA 2010, s 1078 might look like Figure 26.11, where a UK company transfers its Portuguese business to a new Portuguese company. Note that the transferee need not be resident in the same jurisdiction as the location of the transferred business, although it is in many cases, as that is the most common rationale for the transaction in the first place. However, this has been common for Brexit restructuring transactions since 2016, when UK ‘outbound’ companies (ie companies with foreign branches in EU Member States) would transfer these branches to a new or existing company resident in another Member State, often a different jurisdiction from that of any of its foreign branches. This was often to ensure that EU regulatory regimes could continue to apply post-Brexit. Figure 26.11 CTA 2010, s 1078 and TCGA 1992, s 140C

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EU cross-border demergers 26.43 As discussed above, we also believe that TCGA 1992, s 140C(1A) can apply to a reduction of capital demerger, as the legislation does not require the transfer to have been carried out by way of distribution. TCGA 1992, s 140C(2), (3) and (5) – mechanism of relief 26.42 ‘(2) In a case where this section applies, this Act shall have effect in accordance with subsection (3) below. (3) The allowable losses accruing to the transferor on the transfer shall be set off against the chargeable gains so accruing and the transfer shall be treated as giving rise to a single chargeable gain equal to the aggregate of those gains after deducting the aggregate of those losses. (5) In a case where this section applies, section 122 TIOPA 2010 (tax treated as chargeable in respect of gains on transfer of non-UK business) shall also apply.’ Analysis 26.43 As we have already seen with TCGA 1992, s 140, which has similarities to TCGA 1992, s 140C, the relief applies to the net aggregate gain arising from the disposals of the assets. Once the single chargeable gain postulated by TCGA 1992, s 140C(3) has been computed, the double taxation provisions of TIOPA 2010, s 122 are applied. Essentially, TIOPA 2010, s 122 tells us to compute the tax that would have been charged on the disposal of the assets in the country where the permanent establishment resided. This is done on the assumption that the Mergers Directive does not apply. The tax chargeable in the UK on the disposal of the assets of the permanent establishment is then restricted to the tax that would have been charged had the permanent establishment paid non-UK tax on the disposal of its assets and a hypothetical double tax relief for that non-UK tax was then given in the UK. Taking our simple example at Figure 26.11, imagine that, absent the Mergers Directive, there would have been a tax charge in Portugal on the disposal of the assets of the Portuguese business to the Portuguese company. Even though the Mergers Directive might prevent that charge arising in Portugal (for example, through the operation of the Portuguese equivalent of TCGA 1992, s 140A), the UK corporation tax on chargeable gains is nevertheless restricted as if double tax relief had been given in respect of the Portuguese tax charge. The policy here is to ensure the coherence of the Mergers Directive. To take our example again, we can see that a UK resident company transferring assets

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26.44 EU cross-border demergers of a permanent establishment in Portugal would expect relief from tax under the local (Portuguese) equivalent of TCGA 1992, s 140A. But the relief would be meaningless if that UK company then just paid the full 26 per cent UK corporation tax on the gains of the permanent establishment. So, the effect would be that the Mergers Directive gives relief in Portugal but merely transfers the whole tax charge to the UK. Hence, to preserve the cohesion of the Mergers Directive, TIOPA 2010, s 122, through the operation of TCGA 1992, s 140C, gives notional relief against the tax that would have been paid if the Mergers Directive had not applied.

What is meant by ‘but for the Mergers Directive’? 26.44 Across the EU, the provisions that adopt the principles established in the Mergers Directive have been enacted differently, with examples that have, in practice, included: (i)

entirely new provisions which implement the Mergers Directive, with no pre-existing local relieving provisions;

(ii) entirely new provisions which go beyond the Mergers Directive, with no pre-existing local relieving provisions; (iii) entirely new provisions which implement the Mergers Directive which operate independently of pre-existing local relieving provisions; (iv) an extension of pre-existing local relieving provisions which fully implement the Mergers Directive; and (v) no new provisions, since pre-existing rules already implemented the Mergers Directive. In each of these cases (except (v)), it should be reasonably clear that the Member State has taken some action to ensure that the domestic provisions are compliant with the Mergers Directive, but the taxpayer should still take steps to ensure that it can demonstrate which local provisions are being relied upon and the tax effect of those provisions not being in point. With respect to (iv), HMRC has indicated that, when computing the notional tax credit under TIOPA 2010, s 122, the pre-existing partial relief rules and the extension to these rules should be treated collectively as giving rise to the relieving provision that implements the Mergers Directive. Scenario (v) is more difficult and is covered in the HMRC manuals at CG45715. Broadly, the onus would be on the taxpayer to demonstrate that the branch jurisdiction would have introduced rules in line with the Mergers Directive and consider what the tax charge would likely have been in the absence of these rules. 614

EU cross-border demergers 26.47 It is therefore vital to understand the local provisions and the mechanism which provides for relief under the Mergers Directive as well as the history of that provision. To what extent can local relief be taken into account in computing the tax charge? 26.45 Where, under the local domestic rules, there are provisions that would have otherwise applied and are entirely independent of the provisions which implement the Mergers Directive, any relief under these rules should be included when considering the tax charge that would have arisen, but for the Mergers Directive, for the purposes of TIOPA 2010, s 122. What is unclear is how far the taxpayer needs to go when considering the reliefs that could be available. For example, where the local branch is part of a fiscal unity with other entities in the group which have losses in the relevant period, the legislation is vague on whether any claims for ‘group relief’ should be deemed to have been made. Read literally, TIOPA 2010, s 122(5)(b) could be read as deeming such relief to have been taken when considering the local tax result but for the Mergers Directive – potentially even where the loss-making entity in question has already surrendered these losses to another member of the group. In practice, this is largely a hypothetical question and the authors are not aware of a real case that has been discussed with HMRC. Whilst HMRC has been helpful in discussions relating to Brexit restructuring, its approach will largely be dependent on the actual facts and circumstances relating to the transaction in question and the general tax landscape at that point in time. TCGA 1992, s 140C(4) – no double relief 26.46 This is only relevant to transfers of assets and branch incorporations and will be looked at in Chapter 28.

TCGA 1992, s 140D – anti-avoidance 26.47 ‘(1) Section 140C shall not apply unless the transfer of the business or part is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to income tax, corporation tax or capital gains tax.

615

26.48 EU cross-border demergers (2) Subsection (1) above shall not apply where, before the transfer, the Board have on the application of the transferor notified that company that the Board are satisfied that the transfer will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as are mentioned in that subsection. (3) Subsections (2) to (5) of section 138 shall have effect in relation to subsection (2) above as they have effect in relation to subsection (1) of that section.’ Analysis 26.48 This provision is almost identical to TCGA 1992, s 140B and the same comments apply.

Securities issued on division of business 26.49 TCGA 1992, ss 140A and 140C provide for exemptions or deferral from tax for the companies involved in a partial division. But neither of them provides for any protection for shareholders, who might otherwise be treated as disposing of some or all of the shares they hold in a transferor company. To put the matter beyond doubt, the regulations introduce TCGA 1992, s 140DA, which ensures that the transactions are treated as if they are a scheme of reconstruction, even if they are not. TCGA 1992, s 140DA – securities issued on division of business 26.50 ‘(1) This section applies where – (a) a transfer of assets to which section 140A(1A) or 140C(1A)(a) applies has taken place, (b) the transferor and the transferee (or each of the transferees) are each resident in a Member State, (c)

they are not all resident in the same State, and

(e)1

the transfer does not constitute or form part of a scheme of reconstruction within the meaning of section 136.

(2) Where this section applies, the transfer shall be treated for the purposes of section 136 as if it were a scheme of reconstruction.

616

EU cross-border demergers 26.53 (3)

Where section 136 applies by virtue of subsection (2) above section 136(6) (and section 137) shall not apply.’

1 As appears in the Act, no subparagraph (d).

Analysis 26.51 TCGA 1992, s 140DA(1) sets out the conditions for the provision to apply. Essentially, this tells us that TCGA 1992, s 140DA applies where there has been a cross-border merger to which either TCGA 1992, s 140A(1A) or 140C(1A) applies, and TCGA 1992, s 136 does not apply to the transaction, because it is not a scheme of reconstruction within TCGA 1992, Sch 5AA. Where these conditions are satisfied, TCGA 1992, s 136 is deemed to apply, anyway, by TCGA 1992, s 140DA(2). The anti-avoidance provisions of TCGA 1992, ss 136(6) and 137 are disapplied in this situation. This is presumably because TCGA 1992, ss 140B and 140C both contain appropriate anti-avoidance provisions, and neither TCGA 1992, s 140A(1A) nor 140C(1A) can apply unless the demergers are being carried out for bona fide commercial reasons and not to avoid tax.

FURTHER RELIEFS FOR CROSS-BORDER DEMERGERS 26.52 There are provisions in respect of loan relationships, derivative contracts and intangible fixed assets equivalent to those for chargeable assets in TCGA 1992, ss 140A and 140C. The TCGA 1992, s 140A equivalents are in various parts of CTA 2009. The provisions equivalent to TCGA 1992, s 140C are contained in TIOPA 2010, ss 116 and 117, which apply to loan relationships, derivative contracts and intangible fixed assets. The Taxes (Amendments) (EU Exit) Regulations 2019 (SI 2019/689) similarly amend each of these regimes to allow the relevant provisions to operate in a post-Brexit environment.

Provisions equivalent to TCGA 1992, s 140A Intangible fixed assets 26.53 The legislation is in CTA 2009, Part 8, Chapter 11. The description of the relevant demerger transactions in CTA 2009, s 819(3) is almost identical to that at TCGA 1992, s 140A(1A). CTA 2009, s 820 tells us that such a transfer 617

26.54 EU cross-border demergers is to be ‘tax neutral’, so long as the intangible fixed assets that are chargeable intangible assets to both the transferor and the transferee, so that the assets are within the scope of UK corporation tax both before and after the transaction. This means that the transferor is not treated as having realised the intangible fixed asset and the transferee is treated as standing in the shoes of the transferor as ‘having held the asset at all times when it was held by the transferor and as having done all such things in relation to the asset as were done by the transferor’ (CTA 2009, s 776). This is broadly equivalent to the no gain, no loss provision in TCGA 1992, s 140A. CTA 2009, ss 831–833 cover the requirement that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax and make provision for pre-transaction clearances. It is interesting to note that CTA 2009, s 819(4) and (5) retain provisions relating to company residence, even though the equivalent provisions in TCGA 1992, s 140A have been repealed. And there is no provision preventing double relief under CTA 2009, ss 818 (equivalent to TCGA 1992, s 139) and 819, although it is difficult to see what impact such double relief would actually have, in any case.

Loan relationships 26.54 The legislation is in CTA 2009, Part 5, Chapter 13. The description of the relevant demerger transactions in CTA 2009, s 421(4) is almost identical to that at TCGA 1992, s 140A(1A). CTA 2009, s 422 generally applies where a loan relationship is transferred as part of the business transfer and the transferee is within the charge to UK corporation tax. Such transfers are treated as being carried out at the notional carrying value of the loan relationship, which is equivalent to its tax adjusted carrying value based on the accounts of the transferor if a period of account had ended immediately before the date when the transferor ceased to be a party to the loan relationship. However, under CTA 2009, s 423, if the transferor company uses fair value accounting, the transfer is treated as being at fair value, which may generate a tax liability, although, in practice, this would usually mean that the loan relationship is taxed on a ‘mark-to-market’ basis and, as such, the merger itself has not technically given rise to the tax charge. CTA 2009, ss 426–428 also require that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax, and they make provision for pre-transaction clearances. There is also a regime TAAR which 618

EU cross-border demergers 26.56 applies to the loan relationship regime (see CTA 2009, s 455B et seq) which should be considered.

Derivative contracts 26.55 The legislation is in CTA 2009, Part 7, Chapter 9. The description of the relevant demerger transactions in CTA 2009, s 674(3) is almost identical to that at TCGA 1992, s 140A(1A). CTA 2009, s 675 generally applies where a derivative contract is transferred as part of the business transfer and the transferee is within the charge to UK corporation tax. Such transfers are treated as being carried out at the notional carrying value of the loan relationship, which is equivalent to its tax adjusted carrying value based on the accounts of the transferor if a period of account had ended immediately before the date when the transferor ceased to be a party to the loan relationship. However, under CTA 2009, s 676, if the transferor company uses fair value accounting, the transfer is treated as being at fair value, which may generate a tax liability, although, in practice, this would usually mean that the derivative contract is taxed on a ‘mark-to-market’ basis and, as such, the merger itself has not technically given rise to the tax charge. CTA 2009, ss 677–679 also require that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax and make provision for pre-transaction clearances. There is also a regime TAAR which applies to the derivative contracts regime (see CTA 2009, s 698A et seq) which should be considered.

Provisions equivalent to TCGA 1992, s 140C 26.56 As noted above, the provisions equivalent to TCGA 1992, s 140C for loan relationships, derivative contracts and intangible fixed assets are in TIOPA 2010, ss 116 and 117. TIOPA 2010, s 116(3) describes transactions almost identical to those referred to in TCGA 1992, s 140C(1A). And TIOPA 2010, s 117 broadly gives an identical relief, by giving credit against the disposal gain for the tax that would have been paid in the other Member State but for the application of the Mergers Directive. TIOPA 2010, s 117(3)–(6) requires that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax, and it makes provision for pre-transaction clearances. 619

26.57 EU cross-border demergers

INTERACTION WITH OVERSEAS EQUIVALENTS TO MERGERS DIRECTIVE PROVISIONS 26.57 In practice, whilst the provisions of the Mergers Directive set out the principles which must be adopted, the implementation into domestic law across each Member State will likely be different. As a result, it is necessary to consider each of the relevant sets of provisions and ensure that the transaction in question complies with the conditions of each. In practice, we have seen the following additional requirements imposed by other Member States which could require the transaction to be undertaken differently: ●●

A requirement that the shares issued represent the fair market value of the business transferred. This can be difficult to demonstrate, especially where the transferor is not the sole shareholder of the transferee before the transfer. A valuation exercise would have to be undertaken and it would be necessary to consider the appropriate split between share capital and share premium.

●●

A requirement that the conditions for meeting the tax neutrality conditions are met for a specified time following the transfer. In the context of a Brexit reorganisation, this rule could potentially misfire, as the test that both the transferor and transferee are resident in an EU Member State would not be met post-Brexit.

●●

A requirement that the shares issued by the transferee are held by the transferor for a specified period of time. This might be difficult where the transaction results in a cross-shareholding which the group would like to tidy up, as the latent gain could be triggered.

●●

Deeming that the shares issued are momentarily held by the local branch of the transferor, with a subsequent reallocation to head office which is subject to the branch remittance tax. This approach could be argued to be contrary to the Mergers Directive as there is a potential tax leakage, despite the conditions for the Directive to apply having been met. It might also be worth noting that a local participation exemption could partially mitigate this tax charge in certain circumstances.

●●

A requirement for a ruling to be obtained from the local tax authority to be able to benefit from neutrality. This requirement has largely been removed following the ECJ case of Euro Park Service (C-14/16), but it is a good example of how local rules can differ.

The point here is that it is not sufficient to merely consider the UK provisions when entering into a transaction that falls within TCGA 1992, s 140C.

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EU cross-border demergers 26.59 It is necessary to consider the local tax and corporate law provisions in each relevant jurisdiction and appropriately deal with any local nuances to ensure any future tax audit risk has been properly mitigated.

UK EQUIVALENTS TO MERGERS DIRECTIVE DIVISIONS 26.58 We have noted that none of the UK mechanisms that we have discussed are equivalent to a ‘division’, as defined by the Mergers Directive. But have we missed something? We saw in Chapter 17 that CA 2006, Part 26 apparently permits the dissolution without winding up of a transferor company (CA 2006, s 900(2)(d); see 17.5). We have also considered the equivalence of dissolution without winding up with the concept of dissolution without liquidation in the Mergers Directive (see, for example, 4.19). So, it would appear that we have a mechanism at CA 2006, ss 899 and 900 whereby a company could, indeed, transfer its assets to new companies and be dissolved without going into liquidation, which would be a division for the purposes of the Mergers Directive. We have never seen a demerger using this mechanism, although it appears theoretically available. There is no UK tax legislation specific to such a transaction but the analysis in terms of the TFEU and the Mergers Directive would be the same as for a liquidation demerger (see above), including its compliance, or lack thereof, with the TFEU.

CONCLUSION – LEGISLATION ARISING FROM THE EU MERGERS DIRECTIVE 26.59 It appears clear that many of the UK domestic provisions for demergers do not stack up in terms of compliance with the TFEU. Furthermore, there is no correlation between the UK’s demerger mechanisms with their appropriate tax reliefs and the Mergers Directive concept of divisions or partial divisions. So, some mechanisms for UK demergers may also qualify for the reliefs enacted for the purposes of compliance with the Mergers Directive, but others do not. While transactions that would qualify as Mergers Directive ‘divisions’ may be theoretically possible under UK company law, there is no UK tax legislation specifically directed at these transactions but their technical analysis would appear to be fundamentally the same as for a liquidation demerger.

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26.60 EU cross-border demergers

STAMP TAXES 26.60 The incidence of stamp taxes is not generally dependent on the place of incorporation or residence of the transferor and transferee. Therefore the fact that a demerger may be cross border should not affect the stamp tax position. The comments in previous chapters on the different types of demerger will apply equally to equivalent forms of demerger with a cross-border dimension.

VALUE ADDED TAX TCGA 1992, s 140A(1A) cases 26.61

Let us first of all look at a TCGA 1992, s 140A(1A) case.

Transferor company UK resident, transferee company not 26.62 Here the part business being transferred is necessarily being carried on in the UK – this is one of the rules of TCGA 1992, s 140A(1A). Therefore, the exercise will ordinarily be a transfer of a going concern (‘TOGC’) under the UK TOGC rules. For those rules, see 23.26. One of the rules is that, if the transferor is registered for UK VAT, the transferee must also be registered, registerable or accepted for voluntary registration for UK VAT: but, as the business is being carried on in the UK, one would ordinarily expect, if it makes taxable supplies, the transferee to have to, or to choose to, register for UK VAT. Bear in mind the rules about registration: to be a TOGC the transferee must either be actually registered at the time of supply, or be compulsorily registrable, or, if not compulsorily registrable (if, for example, the turnover of the relevant part of the business is below the threshold), it must have been accepted for voluntary registration. If the business is taxable, the transferor company will be entitled to a refund of its input VAT on its incidental costs. See 23.26. The transferee company makes no supply as part of the transaction; it issues shares or debentures which, as we have seen, on general principles is not a supply for VAT purposes. Any input VAT which it incurs in connection with the exercise will be input VAT related to the activities of the business that it acquires. As to whether the shareholders in the transferor company are making a supply: the first question as always is whether they hold their shares as part of a relevant business. If they do, the way in which the transaction is carried out as a matter of company law is relevant. However, in our view either the clear view or the 622

EU cross-border demergers 26.64 better view is that they make no supply. If they did make a supply, it would be exempt (they are, in substance, disposing of an interest in their shares).

Transferor company not UK resident, transferee company UK resident 26.63

Alternatively, the transferor is not UK resident but the transferee is.

Here the analysis is very similar, because the part business being transferred is, of course, being carried on in the UK. The transfer by the transferring company will, therefore, ordinarily be a TOGC under the UK TOGC rules. If the business makes taxable supplies, the transferor will be registered for UK VAT. If so, the transferee company must comply with the registration requirement, see above. The position of the transferee company and the shareholders is as above. Occasionally the position may be a bit more complicated. For example, although the part business has to be carried on in the UK, it might be that there is to be transferred, as part of that part, some plant, stock or other goods situated in another country. If this is the case, it is necessary to look at the VAT rules, if any, of that country. If the country has a TOGC rule, it may well be that the transfer of those goods will be covered by its TOGC rule, even though the main assets involved in the incorporation are elsewhere. If not, there may be a local VATable supply, on which the transferee company will have to seek a refund of the input VAT.

TCGA 1992, s 140C(1A) cases 26.64 Here the part business being transferred is necessarily carried on outside the UK. The exercise typically involves the transfer of stock, plant and other goods situated in that country to the transferee, and the provision of services (for example, the transfer of IP rights) to the transferee. The place of supply will typically be in the country in which the business is carried on. If the business makes taxable supplies, one would expect the transferor to be registered for VAT in that country, and for the transferee to register or become registered. Therefore, it is that country’s VAT rules which will apply. The VAT treatment essentially depends on whether that country has a TOGC rule. The EU VAT Directive does not require countries to have a TOGC rule, and not all EU countries do. If the country does have a TOGC rule, its terms need to be carefully examined to see whether the exercise will fall within it: TOGC rules vary. If it has no TOGC rule, or if it does not apply, there will be an actual supply of goods and services to the transferee which will be VATable supplies 623

26.64 EU cross-border demergers unless they are exempt or zero-rated. The transferee company will apply for a refund as input VAT of the VAT charged, invoking general VAT principles. If the exercise does constitute a TOGC, input VAT incurred by the transferring company on the costs of the exercise should, following the Abbey National case (see 23.26), count as input VAT of the activities being transferred and, if it is carrying on a taxable business, be recoverable by it on its overseas VAT registration. The position of the transferee company and the shareholders is as above.

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Part 7

Branch incorporations

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Chapter 27

Incorporation of non-UK branches

INTRODUCTION 27.1 There are two sets of legislation covering the taxation of branch incorporations, ie where a branch activity (more correctly referred to as a permanent establishment) is incorporated into a subsidiary company. The first of these, covered in this chapter, is TCGA 1992, s 140 and is one of the older pieces of legislation on chargeable gains. The second, in Chapter 28, is the legislation on incorporation of EU branches, TCGA 1992, ss 140A–140D, enacted as a result of the EU Mergers Directive.

FOREIGN PERMANENT ESTABLISHMENT EXEMPTION 27.2 The foreign permanent establishment (‘PE’) exemption in CTA 2009, Part 2, Chapter 3A provides an exemption for any profits and losses (including chargeable gains and losses) that are attributable to a foreign permanent establishment. In addition to the reliefs provided in TCGA 1992, ss 140 and 140A–140D, this exemption might also be a relevant mechanism for ensuring that the transfer or incorporation of a non-UK branch does not crystallise a UK tax charge. There are a few practical points to note: ●●

An election needs to be made for the exemption to apply and the exemption would generally apply from the start of the next accounting period following the time of the election. The election can be revoked before it is effective.

●●

The exemption is irrevocable once effective and applies to all foreign PEs (including those established in the future).

●●

Where a company’s foreign PEs have a net loss position over the six-year period preceding the accounting period in which the election would otherwise have had effect, the exemption is not effective until these losses have been offset against future income arising in the foreign PEs. This period is extended where there are ‘large’ losses (more than £50 million in respect of any foreign territory for an accounting period 627

27.3 Incorporation of non-UK branches beginning within the period of six years ending 18 July 2011), and streaming elections can be made to accelerate the entry of the company into the exemption. ●●

Profits from an investment business are not included within the exemption, and the regime adopts the same anti-diversion tests as the UK CFC provisions, which would also need to be considered.

Where a company has an effective foreign PE exemption election in place, any profits and losses (including capital gains which are attributable to its foreign PEs) are exempt for the purposes of UK corporation tax. The key to ensuring whether a company has an effective foreign PE exemption election is to consider (i) whether it has made an election, and (ii) whether the transitional rules relating to losses are in point. Assuming a company has an effective foreign PE exemption election in place, it would not be necessary to consider the effect of TCGA 1992, ss 140 and 140A–140D as there would be no UK corporation tax liability to relieve. Were a loss would otherwise crystallise as a result of the disposal of a chargeable asset, the effect of a foreign PE exemption election is that such loss would also be exempt for the purposes of UK corporation tax. This would be regardless of whether or not the transitional rules apply, since a loss arising after the election has been made cannot make the opening negative amount (ie the opening net loss) larger.

History of TCGA 1992, s 140 27.3 When capital gains tax was introduced in 1965, there was a provision for the tax-free transfer of a business as a going concern to a company (FA 1965, Sch 7, para 8). The relief applied if the whole business (or the whole business except for cash) was transferred to a company in return for an issue of shares. The shares issued were then treated as being the same asset as that transferred, so having the same base cost and having been acquired at the same time as that asset. If only part of the consideration was in shares, the relief was apportioned appropriately. Readers will, of course, realise that this provision is the forerunner of the current TCGA 1992, s 162, the so-called ‘incorporation relief’, although this provision only applies where the transferor is an individual. When originally enacted, the provision did not specify the nature of the transferor, so it applied to corporate transferors too. Since the nationality of the transferee company was also not specified in the legislation, this relief permitted companies to transfer overseas businesses to overseas companies in a tax-efficient manner.

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Incorporation of non-UK branches 27.3 The relief was changed in FA 1968, Sch 12, para 16 so that it applied only to individuals for transfers made after 10 April 1968. The reason, which was given in the Notes on Clauses for FA 1969, was that the change was an anti-avoidance measure ‘to prevent a method of avoidance of tax that had come to notice’. However, this meant that there was now no relief from the capital gains charge for a company that legitimately might want to incorporate an overseas branch. Ministers were persuaded, notably by the insurance industry (the Notes on Clauses refer extensively to the British Insurance Association), that such a relief was necessary for UK businesses to be able to compete properly overseas, particularly in the US. In many jurisdictions, companies that had historically operated through branches outside the UK were required to incorporate these due to ‘local nationalist pressures’. This requirement also often left the UK parent company with only a minority interest in the new local company. In other cases, setting up a branch was a matter of rationalising business structures. Either way, the government agreed that some form of relief should be available for companies and that the new relief should apply from 10 April 1968, the date the original relief ceased to apply to companies. It was decided that the relief should be given by way of computing the gains that would accrue on the disposals, then holding those gains over until the assets were disposed of by the transferee company. Ministers were also mindful of the difficulties of tracking the ongoing activities of the transferee company, so decided to put a back-stop period of 10 years in place too. The revised relief for companies was introduced as FA 1969, Sch 19, para 18. As noted above, it had retrospective effect and applied to any transfer after 10 April 1968, so that it applied to any transfers that had taken place since the abolition of the original relief. As discussed, it took the form of a hold-over relief where a UK resident company transferred a non-UK trading branch or agency to a non-UK company. The qualifying conditions for this early relief were very similar to those of the current TCGA 1992, s 140 (see below). The assets of a non-UK trade had to be transferred to a non-UK company in return for an issue of shares or shares and loan stock to the transferor company, so that the transferor held at least 25 per cent of the transferee company’s ordinary share capital. If there was an element of cash consideration from the transferee company, the relief was restricted to an appropriate proportion of the gains. If, and to the extent that, the relief applied, the chargeable gain was held over until the earlier of a number of events occurred. These included a disposal

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27.4 Incorporation of non-UK branches of the transferred assets by the transferee company, the transferee company ceasing to use them in a trade, the disposal of the shares by the transferor company or the winding up of the transferor company. Finally, the gain would come back into charge 10 years after the transfer. This relief became ICTA 1970, s 268 before being repealed in 1977 and replaced by what is now TCGA 1992, s 140 (originally ICTA 1970, s 268A).

Modernisation of the relief 27.4 In FA 1977, this relief was replaced by ICTA 1970, s 268A, which replaced the existing ICTA 1970, s 268. The main difference was to provide for a permanent postponement of the chargeable gain in qualifying cases, not just a hold over for the maximum of 10 years in ICTA 1970, s 269. ICTA 1970, s 268A was very similar to the current TCGA 1992, s 140. We are not told why a new, improved relief was required, although there is a comment in Hansard that refers to the change being the implementation of the recommendations ‘made by a joint working party of the Inland Revenue and representative bodies’ to give ‘an improved roll-over relief for … the transfer of an overseas branch to a separate non-resident company’1. We will cover the detail of the current legislation shortly and the original enactment is not sufficiently different as to make any separate analysis worthwhile. However, it is again worth noting a degree of retrospection. The new legislation applied to all transfers on or after 29 March 1977, but it also applied to held-over gains under the old ICTA 1970, s 268. As a result, gains that had already been held over for an assumed maximum of 10 years were effectively converted into permanently postponed gains under ICTA 1970, s 268A.

1 Hansard, 29 March 1977, col 277.

THE LEGISLATION 27.5 The current form of the relief is at TCGA 1992, s 140. The only changes since 1977 are those consequential on other changes in the Taxes Acts. There is an equivalent relief for the transfer of intangible fixed assets in CTA 2009, Part 8. This relief is broadly similar in operation to TCGA 1992, s 140 and is discussed later in this chapter.

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Incorporation of non-UK branches 27.7

TCGA 1992, s 140 – postponement of charge on transfer of assets to non-resident company TCGA 1992, s 140(1) – the basic conditions 27.6 ‘(1) This section applies where a company resident in the United Kingdom carries on a trade outside the United Kingdom through a permanent establishment and – (a) that trade, or part of it, together with the whole assets of the company used for the purposes of the trade or part (or together with the whole of those assets other than cash) is transferred to a company not resident in the United Kingdom; (b) the trade or part is so transferred wholly or partly in exchange for securities consisting of shares, or of shares and loan stock, issued by the transferee company to the transferor company; (c)

the shares so issued, either alone or taken together with any other shares in the transferee company already held by the transferor company, amount in all to not less than one quarter of the ordinary share capital of the transferee company; and

(d) either no allowable losses accrue to the transferor company on the transfer or the aggregate of the chargeable gains so accruing exceeds the aggregate of the allowable losses so accruing;

and also applies in any case where section 268A of the Income and Corporation Taxes Act 1970 applied unless the deferred gain had been wholly taken into account in accordance with that section before the coming into force of this section.’

Analysis 27.7 As mentioned already, this provision sets out the qualifying conditions for the relief. Fundamentally, there must be a UK resident company carrying on a trade outside the UK through a permanent establishment. The permanent establishment is broadly the modern-day equivalent of the branch or agency referred to in the original legislation, with the words ‘branch or agency’ replaced with ‘permanent establishment’ by FA 2003 with effect from 31 December 2002. One of the problems with this legislation is how to identify whether a permanent establishment has a trade. Normally, this is a fairly straightforward analysis, but we have seen a number of cases where the permanent establishment is clearly

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27.7 Incorporation of non-UK branches carrying on a business, but it is not clear whether these activities amount to a trade. This problem arises most frequently where the permanent establishment is involved in activities that are ancillary to the main trade of the group. For example, if the permanent establishment holds valuable group intellectual property and licenses it out to other group members, does this amount to a trade or is it an investment activity? It is these areas of uncertainty that need to be resolved before a permanent establishment is incorporated. There are no simple answers for the hard cases here and each must be considered on its own merits. The next condition is that the UK resident company must transfer the trade or part of the trade of the permanent establishment, with all of the assets of that trade or part of the trade, to a non-UK resident company. However, the transferor is entitled to retain cash pertaining to the permanent establishment’s trade. Note also that there is no reference to the country of residence of the transferee company. It is implicit in the words of the statute that the transferee company can be resident in either the same state as the permanent establishment or in a third state, which is neither the UK nor the state of the trading permanent establishment. In such a case, of course, the permanent establishment of the UK resident company will become a permanent establishment of the transferee company. Therefore, TCGA 1992, s 140 can be used for both branch incorporations (as is discussed in this chapter and involves the transfer of the business of a foreign PE into a new overseas subsidiary in return for shares in that subsidiary) and a contribution in kind of a PE in exchange for the issue of shares (which involves the transfer of the business of a foreign PE to another company in return for shares in that company). The consideration must be securities, either shares or loan stock, issued by the transferee company to the transferor company (TCGA 1992, s 140(1)(b)). After the transfer and issue of shares, the transferor must hold at least 25 per cent of the ordinary share capital of the transferee (TCGA 1992, s 140(1)(c)). This can include shares of the transferee held previously by the transferor, such that the shares issued as consideration need not equate to 25 per cent of the ordinary share capital of the transferee company where the transferor company already held shares in the transferee company, as long as the 25 per cent test is met as a result of the transfer (this is very similar to Case 1 of TCGA 1992, s 135; see 8.6). The last condition is that there must actually be an overall aggregate chargeable gain (TCGA 1992, s 140(1)(d)). This ensures that the relief is only available if there is an aggregate gain and only to the extent of that aggregate gain.

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Incorporation of non-UK branches 27.9 Since the gains or losses on disposal of each of the assets by the UK company are computed separately for capital gains tax purposes, without this provision (and TCGA 1992, s 140(3) below), it might be open to transferor companies to treat the allowable losses and chargeable gains separately. Any allowable losses that arise on the disposal of the assets of the permanent establishment might be set against chargeable gains arising on disposals of other assets during the accounting period leaving the chargeable gains on the disposal of the assets of the permanent establishment to be postponed using the instant relief. Finally, we are told that gains postponed under ICTA 1970, s 286A, before the 1992 consolidation of the capital gains legislation, are also to be dealt with under this provision so long as they are still deferred and have not been brought into account. Figure 27.1 shows a transaction to which TCGA 1992, s 140(1) might apply. Figure 27.1

TCGA 1992, s 140(2) – the claim 27.8 ‘(2) In any case to which this section applies the transferor company may claim that this Act shall have effect in accordance with the following provisions.’ Analysis 27.9 This subsection ensures that the relief has to be claimed by the transferor company. This means that all the UK corporation tax provisions relating to claims will apply to TCGA 1992, s 140. 633

27.10 Incorporation of non-UK branches TCGA 1992, s 140(3) – the relief 27.10 ‘(3) Any allowable losses accruing to the transferor company on the transfer shall be set off against the chargeable gains so accruing and the transfer shall be treated as giving rise to a single chargeable gain equal to the aggregate of those gains after deducting the aggregate of those losses and – (a) if the securities are the whole consideration for the transfer, the whole of that gain shall be treated as not accruing to the transferor company on the transfer but an equivalent amount (“the deferred gain”) shall be brought into account in accordance with subsections (4) and (5) below; (b) if the securities are not the whole of that consideration – (i)

paragraph (a) above shall apply to the appropriate proportion of that gain, and

(ii) the remainder shall be treated as accruing to the transferor company on the transfer.

In paragraph (b)(i) above “the appropriate proportion” means the proportion that the market value of the securities at the time of the transfer bears to the market value of the whole of the consideration at that time.’

Analysis 27.11 This subsection primarily ensures, with TCGA 1992, s 140(1)(d), that the relief applies to the aggregate gains, net of allowable losses, arising on the transferor company’s disposal of the permanent establishment. The reason for this has already been discussed. It is not clear from the legislation but we would assume that relief would also be given for any taxation of the gains of the permanent establishment itself in the non-UK jurisdiction. This is mainly because there is no express provision which precludes the general double tax relief provisions from applying where TCGA 1992, s 140 applies. If the only consideration received by the transferor company was the securities (shares and loan stock of the transferee), then the whole of the gain is deferred until an event in TCGA 1992, s 140(4) or (5) occurs. If there was some other form of consideration – cash, for example – then part of the gain is charged immediately. The appropriate proportion of the gain to be postponed is given by the proportion of the market value of the securities issued to the market value of the whole of the consideration given. Put simply, if half the consideration was given in cash, then only half the aggregate net gain can be deferred. 634

Incorporation of non-UK branches 27.13 The effect of this provision is consistent with the general policy objectives of the chargeable gains provisions that a cash tax liability only generally arises at the point in time at which cash or cash equivalents have been received by the transferor as consideration for the transfer. TCGA 1992, s 140(4), (4A) and (4B) – disposal of the securities 27.12 ‘(4) If at any time after the transfer the transferor company disposes of the whole or part of the securities held by it immediately before that time, there shall be deemed to accrue to the transferor company as a chargeable gain on that occasion the whole or the appropriate proportion of the deferred gain so far as not already taken into account under this subsection or subsection (5) below.

In this subsection “the appropriate proportion” means the proportion that the market value of the part of the securities disposed of bears to the market value of the securities held immediately before the disposal.

(4A) A chargeable gain which is deemed to accrue under subsection (4) is in addition to any gain or loss that actually accrues to the transferor company on the disposal of the securities. (4B) In determining whether a chargeable gain is deemed to accrue under subsection (4),any disapplication of section 127 by paragraph 4(3)(a) of Schedule 7AC in a case in which that section would otherwise have applied shall be disregarded.’ Analysis 27.13 It is clear from what we have seen so far that the purpose of the legislation is postponement of a charge to tax in respect of the disposal of the assets of a trading permanent establishment. This legislation is not intended to grant a permanent relief. Therefore, it is necessary to define the events that trigger the recapture of the deferred gains, unlike TCGA 1992, s 140C (covered in Chapter 28) which provides a complete exemption. The first event brought into charge is a disposal of the securities issued by the transferee company. At its simplest, if the transferee company is sold, the entire gain is brought into charge. If only a proportion of the securities is sold, the same proportion of the gain is brought into charge. The proportion brought into charge is based on the market value of the securities sold to the market value of the holding immediately before sale. There is an important point to note here, especially in respect of loan stock of the transferee. While an actual sale of the loan stock is clearly caught by the legislation, so is a disposal by any other route such as redemption, forgiveness 635

27.13 Incorporation of non-UK branches or insolvency of the transferee. As a result, much like gains deferred under TCGA 1992, s 116(10)(a), it is possible for a gain to come back into charge without the company having cash to pay the tax bill (which is a specific example that is contrary to the general policy objectives of the chargeable gains provisions described above). The mechanism of charge was amended by FA 2010, with effect from 6 January 2010 to block an avoidance arrangement. Originally, the deferred gain was treated as further consideration on the disposal. But if the deferral had been into mainly loan stock, and the transferor company sold the loan stock and not shares, such a disposal is outside the scope of corporate chargeable gains (by TCGA 1992, s 115), and the deferred gain was effectively avoided. Now the deferred gain is treated as a gain accruing to the transferor company and this avoidance route is no longer available. One consequence of the mechanism of charge is that if the disposal of the securities of the transferee generates an allowable loss, that loss might not be able to shelter some or all of the gain that was deferred. For example: (a) company A has a permanent establishment and its assets have an aggregate market value of £10 million. There is negligible base cost; (b) company A decides to incorporate the permanent establishment and the consideration is entirely in the form of ordinary share capital of the transferee; (c)

an aggregate gain of £10 million arises and a claim is made to defer the gain under TCGA 1992, s 140(3);

(d)

unfortunately, the transferee company fails to thrive and, four years later, all the shares of the transferee are sold to a third party for only £5 million;

(e) by TCGA 1992, s 140(4), the disposal consideration is increased by the deferred gain of £10 million, giving a net gain of £5 million. On one analysis, what has effectively happened is that the gain of £10 million is brought back into charge when the ordinary share capital of the transferee company is sold. However, that disposal has itself generated a loss of £5 million, so the net gain brought into charge is only £5 million. In a sense, the combination of the deferral under TCGA 1992, s 140(3) and the recapture under TCGA 1992, s 140(4) is to charge the net real gain on the disposal of the assets of the original permanent establishment to a third party. However, what if the consideration at (b), above, had been largely for loan stock? In that case, the disposal of loan stock at (d) generates a deemed chargeable gain of £10 million under TCGA 1992, s 140(4), but the loss is outside the scope of corporate chargeable gains, as a loss on a qualifying corporate bond (TCGA 1992, s 115), so is not available to shelter the gain. 636

Incorporation of non-UK branches 27.13 Another important point about the recapture mechanism is in relation to the substantial shareholding exemption. Since the disposal of a trading company or sub-group by a UK company is exempt under TCGA 1992, Sch 7AC (the substantial shareholding exemption), a disposal of the shares of the transferee company might be assumed to be exempt, too. However, the gain deemed to accrue by TCGA 1992, s 140(4) is not a gain on disposal of a substantial shareholding, so the deferred gain on incorporating the permanent establishment remains in charge1. A moment’s thought establishes that this is a sensible policy result. The gains deferred under TCGA 1992, s 140 are gains on disposals of assets other than shares and the substantial shareholding exemption is intended only to apply to share sales. So it is entirely within the spirit of the substantial shareholding exemption that deferred gains on asset sales are not exempted. FA 2018 introduced a partial remedy to this with the insertion of TCGA 1992, s 140(4B) which has effect for disposals on or after 22 November 2017. The reason for this being a partial remedy is that TCGA 1992, s 140(4B) is aimed at situations where both TCGA 1992, s 127 (the reorganisation provisions) and TCGA 1992, Sch 7AC (the substantial shareholding exemption) would have applied and, absent TCGA 1992, s 140(4B), the priority rule in TCGA 1992, Sch 7AC, para 4(3)(a) disapplies TCGA 1992, s 127, thereby resulting in there being a ‘disposal’ for the purposes of TCGA 1992, s 140(4) which crystallises the postponed gain. By introducing TCGA 1992, s 140(4B), the ‘no disposal’ treatment for share exchanges applies for the purposes of determining whether there has been a trigger event for the purposes of TCGA 1992, s 140. When introducing this amendment, the joint HMRC and HM Treasury policy document cited this as the correction of an unintended consequence where the postponed gain crystallises even though the group still holds the shares of the transferee company (as a result of the share exchange). For the avoidance of doubt, a sale of the shares in the transferee company would still crystallise the postponed gain, which would appear to be consistent with the policy objectives of TCGA 1992, s 140 as outlined above. To return to the opening comments on this subsection, it was not strictly correct to say that TCGA 1992, s 140 is not a permanent deferral. However, it is only a permanent deferral to the extent that the shares and securities of the transferee company are retained by the transferor (or a member of the same group – see TCGA 1992, s 140(6)).

1 The old rule, treating the deferred gain as further consideration on the disposal of the shares, was specifically excluded from the scope of the substantial shareholding exemption, by TCGA 1992, Sch 7AC, para 35, which was repealed as part of the FA 2010 changes.

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27.14 Incorporation of non-UK branches TCGA 1992, s 140(5) – disposal of the assets 27.14 ‘(5) If at any time within six years after the transfer the transferee company disposes of the whole or part of the relevant assets held by it immediately before that time there shall be deemed to accrue to the transferor company as a chargeable gain on that occasion the whole or the appropriate proportion of the deferred gain so far as not already taken into account under this subsection or subsection (4) above.

In this subsection “relevant assets” means assets the chargeable gains on which were taken into account in arriving at the deferred gain and “the appropriate proportion” means the proportion which the chargeable gain so taken into account in respect of the part of the relevant assets disposed of bears to the aggregate of the chargeable gains so taken into account in respect of the relevant assets held immediately before the time of the disposal.’

Analysis 27.15 The other trigger for the recapture of the deferred charge is a disposal of the assets by the transferee company within six years of the original transaction. The policy behind the six-year period is unknown, although there are other provisions – notably TCGA 1992, s 179, the degrouping charge – with similar ‘claw-back’ periods. This is an interesting restriction on a trading company, however. As a practical matter, it might prevent a trading company moving to more suitable trading premises, for example, if the company is prevented from selling the old premises because of the potential claw-back. This claw-back only applies to ‘assets the chargeable gains on which were taken into account in arriving at the deferred gain’. An interesting question arises from the wording of this provision; is there an argument that TCGA 1992, s 140(5) does not apply where the transferee company sells an asset which generated an allowable loss on the original incorporation of the permanent establishment? Any asset that generated an allowable loss is arguably not one ‘the chargeable gains on which were taken into account in arriving at the deferred gain’. While this might seem far-fetched, the legislation does clearly differentiate between a ‘chargeable gain’, an ‘allowable loss’ and a ‘single chargeable gain’. Therefore, there may be limited circumstances in which assets of a transferee company can be sold within six years of incorporation without penalty. If there is a disposal of assets to which TCGA 1992, s 140(5) applies, the mechanism for recapture of the deferred gain is to deem an appropriate gain to accrue to the original transferor company. Clearly, if all the assets of the 638

Incorporation of non-UK branches 27.18 original permanent establishment were sold, the whole deferred gain would be deemed to accrue on the transferor. The more likely scenario, of course, is that not all the assets are sold. In such a case, only a proportion of the deferred gain comes back into charge, that being the same as the proportion of the original aggregate gain contributed by a disposal of the asset(s). TCGA 1992, s 140(6) – exceptions from charge 27.16 ‘(6) There shall be disregarded – (a) for the purposes of subsection (4) above any disposal to which section 171 applies; and (b) for the purposes of subsection (5) above any disposal to which that section would apply if subsections (1)(b) and (1A) of that section and section 170(9) were disregarded;

and where a person acquires securities or an asset on a disposal disregarded for the purposes of subsection (4) or (5) above (and without there having been a previous disposal not so disregarded) a disposal of the securities or asset by that person shall be treated as a disposal by the transferor or, as the case may be, transferee company.’

Analysis 27.17 There are exceptions from the claw-back of the postponement where the disposals arise only through intra-group transactions. TCGA 1992, s 140(6)(a) exception 27.18 First, in respect of a disposal of the securities issued by the transferee, no charge arises under TCGA 1992, s 140(4) where the securities are transferred to another UK member of the worldwide group, being a transfer to which TCGA 1992, s 171 applies. In such a case, any subsequent disposal of the securities to which TCGA 1992, s 171 does not apply is ‘treated as a disposal by the transferor’. There appears to be some confusion as to which company would have the liability under TCGA 1992, s 140(4) on such a subsequent disposal outside the group. To illustrate this point, let us look at the example given in the HMRC Capital Gains Manual at CG45680: ‘No gain/no loss disposal. TCGA92/S140 (6) provides that there is no charge on the transferor company if the transferor company disposes of shares or loan stock in the transferee company at no gain/no loss 639

27.18 Incorporation of non-UK branches under TCGA92/S171, see CG45300+. Any such no gain/no loss disposal (or any unbroken sequence of no gain/no loss disposals) is left out of account for the purposes of TCGA92/S140 (4). In these circumstances the deferred charge crystallises on the first subsequent disposal of shares or loan stock which is not at no gain/no loss under TCGA92/S171. This first subsequent disposal is treated as a disposal by the original transferor of the permanent establishment assets. The result is that for disposals before 6 January 2010 the consideration for the first subsequent disposal is increased by the appropriate proportion of the deferred gain, as determined by TCGA92/S140 (4). For disposals made on or after 6 January 2010 a chargeable gain equal to the appropriate proportion of the deferred gain is treated as accruing to the transferee in addition to any gain or loss on the shares or securities that actually accrues. Example Company A carries on a trade abroad through a permanent establishment. A also has a UK resident subsidiary, B. A incorporates a new subsidiary, Z, which is not resident in the UK. A transfers the whole of the assets of the permanent establishment to Z. Z issues shares to A as consideration. (The deferred gain on the transfer is £2m. A’s acquisition cost of the shares issued by Z is £3m, reflecting the total value of the assets transferred to Z). A later transfers the shares in Z to B at no gain/no loss under the provisions of Section 171(1). B subsequently sells the Z shares to an unconnected third party for £4m. If the disposal by B takes place before 6 January 2010 the consideration on the disposal is increased by £2m and, ignoring indexation allowance, a chargeable gain of £3m accrues to B. If the disposal by B takes place on or after 6 January 2010 two chargeable gains will accrue to B; the deferred gain of £2m and the actual gain on the shares of £1m.’ We agree with the explanation of the effect of TCGA 1992, s 140(6)(a), but not with the effect shown in the example. HMRC believes that the new owner of the securities effectively takes on the exposure and liability of the original transferor in respect of those securities. In our view, however, the legislation is clearly worded on this point and the subsequent disposal of the securities outside the group is treated as a disposal by A, the original transferor. We rely for our interpretation on the words ‘treated as a disposal by the transferor’. The ‘transferor’ in this context is clearly the original transferor, the company that has claimed relief under TCGA 1992, s 140(3) on incorporating its non-UK trading permanent establishment. So the subsequent disposal of the securities

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Incorporation of non-UK branches 27.18 of the non-UK transferee company triggers a capital gains charge, including the TCGA 1992, s 140(4) enhancement, as if the original transferor had made that disposal. So we can see no reason for the charge to lie on any company other than that original transferor. Putting it another way, the section states that ‘where a person [which must be B in the above example] acquires securities, a disposal by “that person” [ie B] shall be treated as a disposal by the transferor [ie this must be someone other than B and can only be the original transferor]’. If the draftsman had meant the tax to accrue to B, he or she would have used the words ‘that person’ as they do earlier in the subsection. From the words of the legislation, it appears that the TCGA 1992, s 140(4) charge will apply if the securities are transferred within the group, but to a non-UK resident company, on a transfer to which TCGA 1992, s 171 does not apply. This is more restrictive than the exception for intra-group disposals of the assets at TCGA 1992, s 140(6)(b). Arguably, this restriction also falls foul of the fundamental freedoms of the EU, particularly that of free movement of capital. There is no reference in TCGA 1992, s 140(6) to the consequences of a deemed reorganisation under TCGA 1992, s 135 or 136. Imagine, for example, that a new sub-holding company is interpolated between the transferee company and the transferor company and that this is a deemed reorganisation under TCGA 1992, s 135. At first glance, the transferor has disposed of the shares or securities of the transferee company in a transaction to which TCGA 1992, s 171 does not apply (because of TCGA 1992, s 171(3)). However, the application of TCGA 1992, s 135 is to deem there to have been a reorganisation of the share capital of the transferee company, so that TCGA 1992, s 127 applies. TCGA 1992, s 127 deems there not to have been a disposal of share capital by the transferor and we take the view that this extends to deeming there to have been no disposal for the purposes of TCGA 1992, s 140(4). On this analysis, a share-for-share exchange should not generate a TCGA 1992, s 140(4) charge. Therefore, one could argue that there is no need to specifically mention TCGA 1992, s 127 but, given the interaction between the various reliefs as outlined in Chapter 12, the intra-group transfer provisions at TCGA 1992, s 171 rarely apply if the reorganisation provisions and/or the substantial shareholding exemption could apply. This therefore warrants a specific provision in TCGA 1992, s 140 to deal with a transfer that could fall within TCGA 1992, s 171. The other interesting result is that TCGA 1992, s 127 tells us that the shares of the interpolated company owned by the original transferor company are to be

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27.19 Incorporation of non-UK branches treated as the shares of transferee, but this would mean that the transferor must treat the shares of the interpolated company as if they were the same shares as the shares the transferor originally held in the transferee. This would mean that TCGA 1992, s 140(4) would now apply only if the transferor company sells the shares of the interpolated company, not the actual transferee company! Furthermore, since the transferor company no longer holds the transferee company shares, no TCGA 1992, s 140(4) charge can arise on a disposal of the transferee company shares. This is because TCGA 1992, s 140(4) clearly requires a disposal by the transferor, not any other company and TCGA 1992, s 140(6) only brings TCGA 1992, s 140(4) into play if there was a TCGA 1992, s 171 transfer of the transferee shares, which is not the case in a reorganisation, as already discussed, because of TCGA 1992, s 171(3). As a parting comment on this matter, the reorganisation provisions only apply where the transaction is carried out for bona fide commercial reasons and not for the avoidance of tax. It may be that the TCGA 1992, s 140 tax consequences of a reorganisation are such that it would be hard to persuade an inspector or higher authority that the reorganisation satisfied these conditions. If the reorganisation provisions do not apply, the transfer of the transferee to the interpolated company would fall into TCGA 1992, s 171, so that the basic provisions of TCGA 1992, s 140(6) would be in point. However, it is clear to the authors that an inadvertent effect of the application of TCGA 1992, s 140 might be that, for an otherwise bona fide transaction where TCGA 1992, s 127 could validly apply, the sale of shares in the transferee company could result in the postponed gain not being brought into account. TCGA 1992, s 140(6)(b) exception 27.19 The other exception provides that there is no charge under TCGA 1992, s 140(5) if the assets are transferred by the transferee to any other group company, even if it is not UK resident (by disregarding the test in TCGA 1992, s 171(1A)). Obviously, this must be the case, as the transferee company is, by definition, not UK resident, so it cannot make any TCGA 1992, s 171 transfers. So the original transferee company could transfer the assets to a company resident in any country in the world (even the UK, presumably) without triggering the claw-back. Again, any eventual disposal outside the group would trigger a TCGA 1992, s 140(5) charge on the original transferor company. The legislation operates by deeming such a subsequent disposal to have been made by the original transferee company, so that TCGA 1992, s 140(5) applies and the charge is made on the original transferor company.

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Incorporation of non-UK branches 27.23 TCGA 1992, s 140(6A) – no double relief 27.20 ‘(6A) No claim may be made under this section as regards a transfer in relation to which a claim is made under section 140C.’ Analysis 27.21 This provides that relief cannot be given under both TCGA 1992, ss 140 and 140C. TCGA 1992, s 140C is a provision for incorporation of an EU permanent establishment with some similarities to TCGA 1992, s 140. It is analysed in the next chapter. TCGA 1992, s 140(6AA) – interaction with Mergers Directive reliefs 27.22 ‘(6AA) If securities are transferred by a transferor company as part of the process of the transfer of a business to which section 140A or 140C applies – (a) the transfer shall be disregarded for the purposes of subsection (4), and (b) the transferee company shall be treated as if it were the transferor company in relation to– (i)

any subsequent disposal of the securities, and

(ii) any subsequent disposal by the transferee of assets to which subsection 5 applies.’ Analysis 27.23 This provision was inserted by SI 2007/3186, as part of the enactment of the enhanced Mergers Directive (see Chapters 26 and 28). It prevents any relief previously given under TCGA 1992, s 140 being clawed back if the shares or securities are subsequently transferred under a business transfer to which TCGA 1992, s 140A or 140C applies. Such transactions are analysed more fully in Chapter 28. The impact of TCGA 1992, s 140(6AA) is that the transferee company in the business transfer under TCGA 1992, s 140A or 140C inherits the deferred liability that arises under TCGA 1992, s 140(4). So, if it subsequently sells the shares or securities, the enhanced consideration is chargeable on the transferee company.

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27.24 Incorporation of non-UK branches Also, if the original transferee company (ie the company that has now been transferred in a TCGA 1992, s 140A or 140C transaction) disposes of any of the assets that had been transferred to it within six years, so that TCGA 1992, s 140(5) applies, the liability that would previously have fallen on the original transferor company is now to fall on the new owner of the transferee’s shares. An example may illustrate this better: ●●

company A incorporates its Gambian branch into a subsidiary and claims relief under TCGA 1992, s 140;

●●

subsequently, the Gambian subsidiary is transferred to company B in a partial division transaction to which TCGA 1992, s 140C applies and relief under that provision is claimed, too;

●●

the Gambian subsidiary sells some of the assets originally acquired from company A;

●●

TCGA 1992, s 140(6AA)(b)(ii) tells us that company B (the transferee company in TCGA 1992, s 140(6AA)(b)) now stands in the shoes of company A, so company B is chargeable under TCGA 1992, s 140(5) on the relevant proportion of the gain arising on the disposal of assets by the Gambian company.

We believe that company B can be resident in any EU Member State, so it is possible that this provision may be unenforceable in many cases. TCGA 1992, s 140(6B) and (6C) – exception for mergers 27.24 ‘(6B) If securities are transferred by a transferor as part of the process of a merger to which section 140E applies – (a) the transfer shall be disregarded for the purposes of subsection (4), and (b) the transferee shall be treated as if it were the transferor in relation to – (i)

any subsequent disposal of the securities, and

(ii) any subsequent disposal by the transferee of assets to which subsection (5) applies. (6C) In subsection (6B) “transferor” and “transferee” have the meaning given by section 140E(9).’

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Incorporation of non-UK branches 27.26 Analysis 27.25 The original provision, inserted in 2005, prevented a gain being reinstated under TCGA 1992, s 140(4) on the formation of a Societas Europaea (‘SE’). Since EU legislation now permits mergers in a wider range of circumstances (Chapter 20), this provision has been extended to cover all forms of merger. TCGA 1992, s 140(6B) now ensures that a disposal of the shares issued in a case where the gain is deferred under TCGA 1992, s 140(2) does not crystallise a held-over gain if the transfer is part of the process of merger into an SE, SCE or ordinary company resident in the UK to which TCGA 1992, s 140E applies. The transferee company in the merger inherits the deferred liabilities, so if it subsequently sells the shares or securities, the deemed gain under TCGA 1992, s 140(4) is chargeable on the company formed by the merger. Similarly, if the original company formed by incorporation of the permanent establishment were to sell the assets within six years of the incorporation, the liability under TCGA 1992, s 140(5) arises on the company formed in the TCGA 1992, s 140E merger. SEs are discussed in detail in Chapter 4. TCGA 1992, s 140(7) and (8) – replication of previous provisions 27.26 ‘(7) If in the case of any such transfer as was mentioned in section 268(1) of the Income and Corporation Taxes Act 1970 there were immediately before the coming into force of this section chargeable gains which by virtue of section 268(2) and 268A(8) of that Act were treated as not having accrued to the transferor company, subsection (4) above shall (without any claim in that behalf) apply to the aggregate of those gains as if references to the deferred gain were references to that aggregate and as if references to the transfer and the securities were references to the transfer and the shares, or shares and loan stock, mentioned in section 268(1). (8) If in the case of any such transfer as was mentioned in section 268A(1) of the Income and Corporation Taxes Act 1970 there were immediately before the coming into force of this section deferred gains which by virtue of section 268A(3) were treated as not having accrued to the transferor company, subsections (4) and (5) above shall (without any claim in that behalf) apply to those deferred gains as they apply to gains deferred by virtue of subsection (3) above (as if the references to the transfer and the securities were references to the transfer and securities mentioned in section 268A(1)).’ 645

27.27 Incorporation of non-UK branches Analysis 27.27 These provisions apply TCGA 1992, s 140(4) and (5), as appropriate, to gains held over under ICTA 1970, s 268 (since before 1977) or ICTA 1970, s 268A (since before 1992). No detailed analysis is given, as we have not seen these provisions operating in practice.

Further provisions for the incorporation of a non-UK permanent establishment 27.28 TCGA 1992, s 140 is, of course, a provision in the capital gains legislation and applies only to chargeable assets. Therefore, legislation is also required in CTA 2009, Part 8 to allow a similar relief in respect of intangible fixed assets. The legislation is at CTA 2009, ss 827 et seq. 27.29 This provision is intended to reproduce TCGA 1992, s 140 for the purposes of the intangible fixed assets legislation. The draftsman has taken a slightly different approach from that used in 1977, although the result is similar. We read nothing into this except a difference of style between draftsmen. Thus, we have the basic conditions which are more or less the same as those for TCGA 1992, s 140, including the same restrictions on the relief where the consideration for the transfer is not wholly in the form of securities. The relief under CTA 2009, s 828 can be claimed in respect of the transfer of chargeable intangible assets of the transferor, standing at a gain on realisation, so long as those chargeable intangible assets are assets of the trade being transferred. The main difference from TCGA 1992, s 140 is that the relief for intangible assets operates on each individual asset, rather than on the aggregate gains on which TCGA 1992, s 140 operates. So the relief is given against the realisation gains of intangible fixed assets without regard to any losses on realisation of other intangible fixed assets. These therefore remain as deductions in arriving at the trading profits of the company. This view is supported by CTA 2009, s 828(1), which refers to ‘the proceeds of a relevant asset’, suggesting that the relief is applied to individual intangible fixed assets, not to the collective proceeds. Double claims to relief are precluded by CTA 2009, s 827(7), which prevents claims under CTA 2009, s 827 if there has been a claim under TIOPA 2010, s 116(6) (European cross-border transfers of business). Similarly, where there has been a claim under CTA 2009, s 827, TIOPA 2010, s 116(7) prevents a claim under TIOPA 2010, s 116(6). The equivalent provision to TCGA 1992, s 140(4) is CTA 2009, s 829. The relief is clawed back on any subsequent realisation of the securities by the transferor by requiring the company to bring into account a credit equal to the 646

Incorporation of non-UK branches 27.31 whole or an appropriate proportion of the ‘total deferred gain’, ie the amount by which the proceeds of realisation of the relevant assets was reduced on the claim under CTA 2009, s 828. If the transferee disposes of the intangible fixed assets within six years, there is a claw-back of relief similar to that in TCGA 1992, s 140(5). Both claw-back provisions are subject to exceptions similar to those in TCGA 1992, s 140(6). However, the further exceptions in TCGA 1992, s 140(6AA) and (6B) are not replicated for some reason in the rules for intangible assets. In contrast to TCGA 1992, s 140, there are also tests for bona fide commercial reasons and for tax avoidance at CTA 2009, s 831, similar to those in TCGA 1992, ss 140B and 140D, together with a procedure for pre-transaction clearance in respect of these tests. While such a test is not surprising, one might ask why such a test has not been introduced into TCGA 1992, s 140.

CONCLUSION 27.30 TCGA 1992, s 140, together with its counterpart in the intangible fixed assets legislation, is an extremely useful provision for the incorporation of non-UK trading permanent establishments, particularly those outside the EU. The disadvantage is that the gain can come back into charge if the shares of the transferee company are sold or otherwise disposed of, or if the assets that give rise to a chargeable gain that are included within the postponed gain are disposed of within six years of the transfer, but this can still represent a deferral of charge until such time.

STAMP TAXES 27.31 The fact that a transaction may be cross border is not directly relevant for stamp tax purposes. Stamp tax charges will arise, and reliefs will be available in just the same way as for the equivalent transaction between UK entities. SDLT, LTT and LBTT are unlikely to be an issue in relation to a non-UK branch which, presumably, is not likely to own UK land or buildings. Practical difficulties sometimes arise in dealing with stamp duty on share transfers, because there are no UK equivalents for the overseas entities involved, or perhaps because there is no UK equivalent for a particular kind of transaction permitted under overseas law – for example a true merger of two companies. Individual analysis is required for final determination of the stamp tax position in such cases, but in general HMRC is likely to look for particular characteristics of the foreign entity/transaction which are similar to those of a UK entity/transaction in order to decide how to treat the overseas entity or transaction. 647

27.32 Incorporation of non-UK branches

VALUE ADDED TAX 27.32 Under TCGA 1992, s 140, the trade or part is necessarily being carried on outside the UK. Typically, the domestication exercise involves the transfer of stock, plant and other goods situated in that country to the transferee and the provision of services (for example, the transfer of IP rights) to the transferee. The exercise will therefore not generally involve any supply in the UK: the goods will be physically situated in the country where the business is being carried on and any services will normally be rendered from the transferor’s business establishment or other fixed establishment there to the business establishment or other fixed establishment of the transferee there. Even if some of the services are regarded as made from the transferor’s HQ in the UK (for example, IP rights), under the rules relating to international services they are treated as made where the transferee belongs (VATA 1994, ss 7A, 9). Therefore, ordinarily UK VAT will not be relevant, and it is the VAT rules, if any, of the country where the business is carried on that will govern. One has to see, first of all, whether that country levies VAT or a similar tax. If it does not, there should be no VAT or similar consequences for the transferor. If the country where the business is carried on does levy VAT or a similar tax, it is necessary to examine its provisions to see how the exercise will be treated. If the country has a TOGC rule (and the EU VAT Directive does not make it compulsory for even EU countries to have a TOGC rule), it will need to be examined carefully to see whether the transaction falls within it and therefore no actual VAT has to be levied. TOGC rules vary and it cannot be assumed that, just because it would be a TOGC if the transaction was entirely a UK one, it will be under the local law. If it is not, the transfer of the business, insofar as it is the provision of VATable goods and services, will constitute actual VATable supplies: the transferee company will be required to, or will want to, register for local VAT, if it is not already, and put in a VAT refund claim on general principles. The transferor’s input VAT can be categorised as follows: ●●

Local input VAT (ie input VAT charged by professionals etc in the country of the business): these would be typically billed to the transferor’s local office. The local VAT law about input VAT recovery will apply, but if the transaction is a TOGC, and the business is a taxable business, it should be recoverable by the transferor on its local VAT registration, and if it is not a TOGC but the transfer is standard-rated it should likewise be recoverable on general principles.

●●

Where UK advisers etc bill the transferor’s office in the country of business, they should not charge UK VAT: the local office, at least if it is 648

Incorporation of non-UK branches 27.32 in the EU, will have a reverse charge output VAT liability to local VAT, which will be recoverable (or not) locally as above. ●●

Where UK advisers etc bill the UK head office, the transferor will be entitled to a refund of the input VAT to the same extent as it would if the incorporation exercise was a wholly UK one: VATA 1994, s 26(2)(b).

As to the transferee’s position, the exercise does not involve its making a supply for VAT, even if the country of the business has a VAT system. If its country does have a VAT system any input VAT the transferee runs up on the expenses of the exercise will relate to the supplies that it will be making in the business that it is acquiring.

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Chapter 28

EU branch incorporations

INTRODUCTION 28.1 When the EU Mergers Directive1 was enacted into UK law in 1992, the legislation now found in TCGA 1992, ss 140A–140D was introduced to comply with the Directive in terms of transfers of assets, effectively branch incorporations. These provisions were expanded to include legislation relevant to partial divisions under the Mergers Directive, as discussed in Chapter 26. In this chapter we will look at the provisions relevant to the cross-border incorporations. As has already been stated earlier in this book, this chapter must, of course, be read subject to any on-going developments in the tax legislation in the UK as a result of the UK leaving the EU on 31 January 2020, though still subject to possible amendment before the IP completion date, currently scheduled for 11pm on 31 December 2020. The future status of all EU Regulations, Directives and case law in relation to UK law will entirely depend on the terms under which the UK ultimately leaves the EU and how domestic statute evolves over time. Domestic legislation enacted under the influence of EU law will remain in force, but now subject to possible amendment by the UK Parliament, which of course is subject to change depending on which Government is in place and its attitude towards the EU. A point to note is that, notwithstanding the Fixed-term Parliaments Act 2011, it is possible to have an election in the UK within the statutory five-year period, as was demonstrated in 2017. Therefore, whilst the next general election is scheduled for 2022, it is possible that a general election could take place earlier. A change in government could lead to a change in how UK law that has been influenced by EU law has effect, even if there hasn’t been a change in the governing party – especially where that party has the opportunity to present a new manifesto. Other than relatively minor amendments to cross-references to other legislation, there have been no material changes to these provisions since 2007. The Taxes (Amendments) (EU Exit) Regulations 2019 (SI 2019/689) have made some prospective amendments to TCGA 1992, ss 140A–140L to allow these 650

EU branch incorporations 28.2 provisions to apply in circumstances when the UK is no longer an EU Member State from the relevant ‘exit day’. This has been included in the commentary below where relevant.

1 Council Directive (90/434/EEC) of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (as amended in 2005).

TRANSFERS OF ASSETS 28.2

Clause 2 of the Mergers Directive tells us that:

‘a “ transfer of assets” shall mean an operation whereby a company transfers without being dissolved all or one or more branches of its activity to another company in exchange for the transfer of securities representing the capital of the company receiving the transfer.’ This transaction is generally taken to refer to the branch incorporation transactions, like those to which TCGA 1992, ss 140, 140A(1) and 140C(1) apply, as illustrated in Figure 28.1. Figure 28.1

Our slight concern with the wording is the reference to the transfer of assets ‘in exchange for the transfer of securities representing the capital of the company receiving the transfer’. The branch incorporation transactions involve an issue of new shares by the transferee company, not the transfer of its existing capital. However, given the widely held view that branch incorporations are transfers of assets, as defined in the Directive, we assume that this must be one of those translation issues that crops up from time to time with EU legislation. 651

28.3 EU branch incorporations In the case of Brexit, where reorganisations have relied upon the local implementation of the EU Mergers Directive in other Member States, in our experience, the condition has generally been the issue of new shares, which is consistent with the view expressed above.

THE LEGISLATION Introduction 28.3 There are two basic sets of relief. TCGA 1992, s 140A applies to the transfer of a business carried on in the UK by an EU resident company to a company resident in another Member State. TCGA 1992, s 140C covers the incorporation of an EU permanent establishment of a UK company into a company resident in another Member State. This latter provision is similar in conception to TCGA 1992, s 140 (Chapter 27), albeit a quasi-exemption rather than deferral in most circumstances (as is discussed in further detail below). Both new reliefs have anti-avoidance clauses, as permitted by EU legislation, and both also have provision for limited clearances in advance of the transactions – TCGA 1992, ss 140B and 140D respectively. There are further provisions to prevent tax charges arising under other legislation too. There is relief under the capital allowances legislation – Capital Allowances Act 2001, s 561 – for the incorporation of a UK permanent establishment under TCGA 1992, s 140A, and there are reliefs under the legislation relating to loan relationships, derivative contracts and intangible fixed assets for transactions to which TCGA 1992, ss 140A and 140C apply.

TCGA 1992, s 140A – transfer or division of UK business TCGA 1992, s 140A(1) – qualifying conditions 28.4 ‘(1) This section applies where – (a) a company resident in one Member State (the transferor) transfers the whole or part of a business carried on by it in the United Kingdom to a company resident in another Member State (the transferee); (b) the transfer is wholly in exchange for shares and debentures issued by the transferee to the transferor; (c)

a claim is made under this section by the transferor and the transferee; 652

EU branch incorporations 28.5 (d) section 140B does not prevent this section applying; and (e)

the appropriate condition is met in relation to the transferee immediately after the time of the transfer.’

Analysis 28.5 This provision is designed to permit transfers of assets, as defined by the Mergers Directive. That is, it applies to ‘an operation whereby a company transfers without being dissolved all or one or more branches of its activity to another company in exchange for the transfer of securities representing the capital of the company receiving the transfer’. To allow TCGA 1992, s 140A to operate in a post-Brexit environment, the words ‘Member State’ have been replaced with ‘relevant state’. This is defined as the UK or an EU Member State and has been introduced by SI 2019/689 from the ‘exit day’ (being the day of Brexit) to allow this provision to continue to apply as before. The effect of this amendment is to prevent TCGA 1992, s 140A from being broadened to apply to demergers with companies outside the EU. The crucial point here is that the word ‘trade’ has been replaced by ‘business’ (with effect from 1 January 2007). This is because the Mergers Directive does not refer to trades, only to activities. So, this change is intended to bring the legislation into conformity with the Directive (implying, of course, that the UK’s implementation was defective and overly restrictive for the last 16 years). That said, by substituting the word ‘trade’ for ‘business’, the circumstances in which TCGA 1992, s 140A could practically apply has potentially been broadened, since TCGA 1992, s 171 would generally be expected to be in point where there is a transfer of assets between two UK permanent establishments of two group companies. However, as discussed in our analysis for TCGA 1992, s 140A(2), the test refers back to TCGA 1992, s 2C which requires consideration of whether or not the transferee carries out a trade in the UK, so perhaps the effect of this distinction is largely irrelevant. TCGA 1992, s 140A(1) sets out the conditions to be satisfied before the relief can be claimed. Firstly, a UK business must be transferred by a company resident in any EU Member State (including the UK) to a company resident in another Member State. If the transferor company is a non-UK company resident in the EU, the business will probably be a UK permanent establishment1 of that company. But TCGA 1992, s 140A(1) does not refer to a permanent establishment, because the relief would also apply to a UK company that incorporates any UK business into a company resident elsewhere in the EU. 653

28.6 EU branch incorporations The transfer must be wholly for shares and debentures. There is a view that the Mergers Directive only requires a deferral where the consideration is in the form of equity, not debt, as the Directive refers to ‘securities representing the capital of [a company]’. However, the introduction to the 1991 consultative document states that the Government considered that this would be unreasonably restrictive and that relief should also be available where the consideration includes debt instruments too. The relief must be claimed by both companies concerned, so the UK corporation tax provisions relating to claims will apply to TCGA 1992, s 140A, and the relief is subject to the anti-avoidance provisions of TCGA 1992, s 140B. Finally, the transferee must satisfy one of the appropriate conditions in TCGA 1992, s 140A(2) or (3). Figure 28.1 shows a transaction to which TCGA 1992, s 140A might apply. In our example, we have a Dutch company with trades in both the UK and elsewhere, and the UK Trade is incorporated into a French company. Thus, the Dutch company is company A in TCGA 1992, s 140A(1)(a) and the French company is company B. A point worth noting is that, in practice, TCGA 1992, s 140A may be unlikely to be relevant as a deferral mechanism since TCGA 1992, s 171 (which operates an almost identical relieving provision) would usually be expected to apply (though noting the distinction as a result of the use of the word ‘business’ rather than ‘trade’, as outlined above). In the view of the authors, TCGA 1992, s 140A appears to be the Parliamentary draftsman taking a ‘belts and braces’ approach to implementing the EU Mergers Directive, notwithstanding the provision could be considered otiose as a result of a pre-existing provision. This might also be as a result of the use of the ‘but for the Mergers Directive’ approach taken in TIOPA 2010, s 122, which is discussed in further detail below.

1 It should be registered at Companies House as a branch.

TCGA 1992, s 140A(1A) to (1D) 28.6 As discussed in Chapter 26, TCGA 1992, s 140A(1A)–(1D) are intended to permit cross-border partial divisions (or demergers), as defined by the Mergers Directive, and are not relevant in an EU branch incorporation context.

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EU branch incorporations 28.8 TCGA 1992, s 140A(2) and (3) – ‘the appropriate conditions’ for transferee 28.7 ‘(2) Where immediately after the time of the transfer the transferee (or each of the transferees) is not resident in the United Kingdom, the appropriate condition is that were it to dispose of the assets included in the transfer any chargeable gains accruing to it on the disposal would form part of its chargeable profits for corporation tax purposes by virtue of section 2B(3). (3) Where immediately after the time of the transfer the transferee (or each of the transferees) is resident in the United Kingdom, the appropriate condition is that none of the assets included in the transfer is one in respect of which, by virtue of the asset being of a description specified in double taxation relief arrangements, the company falls to be regarded for the purposes of the arrangements as not liable in the United Kingdom to tax on gains accruing to it on a disposal.’ Analysis 28.8 TCGA 1992, s 140A(2) explains the appropriate condition for relief under TCGA 1992, s 140A(1) or (1A) if the transferee company is not UK resident. The condition is that the business must be a UK permanent establishment of the transferee company, hence the reference to TCGA 1992, s 2B(3), so that any disposal of the assets of the business will be within the scope of UK corporation tax. The policy behind this condition is that the disposal of the assets is not intended to escape UK corporation tax on any chargeable gain that might accrue on eventual disposal. The interesting point about TCGA 1992, s 2B(3), however, is that it applies only where a company is carrying on a trade through a permanent establishment. So this will apply in more restrictive circumstances than for UK resident companies, which merely have to be carrying on a business (and could be argued to result in more alignment between TCGA 1992, ss 140A and 171). TCGA 1992, s 140A(3) explains the appropriate condition if the transferee company is UK resident. This is that the assets must not be assets that are precluded from UK taxation on disposal by any double tax arrangements. Again, the policy behind this condition is that the company must be subject to UK corporation tax on any chargeable gain that might accrue on disposal of the assets concerned. So the relief is a deferral of tax until the assets are sold by the transferee company, not a permanent exemption.

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28.9 EU branch incorporations TCGA 1992, s 140A(4) – mechanism of relief 28.9 ‘(4) Where this section applies – (a) the transferor and the transferee (or each of the transferees) shall be treated, so far as relates to corporation tax on chargeable gains, as if any assets included in the transfer were acquired by the transferee (or each of the transferees) from the transferor for a consideration of such amount as would secure that on the disposal by way of transfer neither a gain nor a loss would accrue to the transferor; (b) section 25(3) shall not apply to any such assets by reason of the transfer (if it would apply apart from this paragraph).’ Analysis 28.10 The relief operates by treating the transfer to the transferee company as being a ‘no gain no loss’ transfer so that, just like TCGA 1992, s 139, the transfer is deemed to be at a consideration such that no gain or loss would accrue to the transferor. In most cases, this will be a consideration equal to the original cost of the asset plus appropriate indexation allowance to 31 December 2017, the date from which the allowance ceased to accrue. It is noteworthy that the legislation makes no specific provision for the base cost of the shares issued by the transferee company. We assume these shares will be treated as having been issued at market value and this would usually be deemed to be the case for UK tax purposes in a related parties context by virtue of TCGA 1992, ss 17 and 18. TCGA 1992, s 25(3) applies where a non-UK resident person ceases to use an asset in its UK trade and provides for a deemed market value disposal and reacquisition. This needs to be disapplied in the case of an EU company incorporating its UK PE or demerging that PE as, otherwise, the TCGA 1992, s 140A relief would be meaningless. Subsequent disposals of assets or of shares or debentures 28.11 It is appropriate here to look at what happens if either the assets or the shares or debentures of the new company are sold. Following the transfer, the assets will either be in a UK trading permanent establishment or held by a UK resident company (as required by the appropriate

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EU branch incorporations 28.11 conditions, above). If the assets are sold they will effectively only have their original base cost (plus indexation, where appropriate) and the deferred tax will come back into charge, either under TCGA 1992, s 2B(3) as gains of the permanent establishment or as gains of the UK company. The important aspect here is that the relief under TCGA 1992, s 140A(1) is therefore only a postponement of the tax charge. The Mergers Directive is not intended to exempt disposals of assets from the charge to tax. It is only intended to grant the same relief to a cross-border transaction as might be available to a transaction that is wholly domestic. So this provision remains to ensure that a subsequent disposal of the relevant assets out of the group will still be chargeable to tax. What about if the shares or debentures of the new company are sold? Let us first look at a non-UK company incorporating its UK business into a UK transferee company. If the shares or debentures of the UK transferee company are later sold, the gains consequences accrue to the non-UK shareholder and are outside the scope of UK taxation. A charge may arise in the UK transferee company under TCGA 1992, s 179, if the sale is within six years of the original transfer, exactly as would be the case for a domestic transfer of assets within a group. There is no reason for any added protection. (The new degrouping charge mechanism would not apply here if the disposing company is not UK resident or if the shares are not chargeable assets of the company making the disposal.) Alternatively, let us look at a UK company incorporating part of its UK business into a company resident in another Member State (however unlikely such a transaction might appear). We have assumed that the base cost of any shares issued by the transferee at the time of the transfer is the market value of those shares. If the transferee company is later sold out of the group, a chargeable gain will therefore only arise on the UK owner to the extent that the shares have increased in value since the TCGA 1992, s 140A(1) transaction (and subject to the substantial shareholding exemption). If there is a disposal of debentures received as consideration for the transfer of the assets of the permanent establishment, the debentures would be qualifying corporate bonds outside the scope of taxation of chargeable gains by TCGA 1992, s 115. In this situation, remember that the relief under TCGA 1992, s 140A is only available if the UK business is chargeable to UK corporation tax under TCGA 1992, s 2B(3). So, if the non-UK transferee is sold out of the group,

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28.12 EU branch incorporations TCGA 1992, s 179 can again impose a degrouping charge, exactly as for a domestic transfer of assets. However, since the vendor company here is UK resident, the degrouping charge would apply to the vendor company, not the subsidiary, under the FA 2011 rules. If the asset ceases to be a chargeable asset for UK corporation tax purposes, TCGA 1992, s 25 will apply, as described above, to deem a market value disposal and reacquisition. Overall, it is clear that no special rules are required for the future disposal of the transferee company or of the transferred assets. And these analyses also demonstrate the fact that TCGA 1992, s 140A ensures that a crossborder transaction is treated the same for UK tax purposes as a domestic transaction.

TCGA 1992, s 140B – anti-avoidance 28.12 ‘(1) Section 140A shall not apply unless the transfer of the business or part is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to income tax, corporation tax or capital gains tax. (2) Subsection (1) above shall not apply where, before the transfer, the Board have on the application of the transferor and the transferee (or each of the transferees) notified those companies that the Board are satisfied that the transfer will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as are mentioned in that subsection. (3) Subsections (2) to (5) of section 138 shall have effect in relation to subsection (2) above as they have effect in relation to subsection (1) of that section.’ Analysis 28.13 This is a straightforward anti-avoidance provision with tests and clearance rules with which most readers will be familiar. Essentially, our old friends the tests for bona fide commercial reasons and for tax avoidance motives are applied to TCGA 1992, s 140A, but to give certainty to taxpayers,

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EU branch incorporations 28.15 a clearance is available from HMRC. This is governed by TCGA 1992, s 138 which is discussed in detail earlier in the book. One caveat is that, as always, the clearance only confirms the HMRC view that the transaction satisfies the tests relating to bona fide commercial reasons and to tax avoidance motives. The clearance will not confirm that the transaction otherwise complies with the detailed provisions of TCGA 1992, s 140A. So, for example, if there is any doubt as to whether the activities in the UK amount to a trade, the taxpayer should seek comfort by carefully analysing the tests set out in statute, case law and related materials, seeking the assistance of advisers as appropriate, but with no confirmation or blessing to be expected from HMRC.

TCGA 1992, s 140C – transfer or division of a non-UK trade TCGA 1992, s 140C(1) – qualifying conditions 28.14 ‘(1) This section applies where – (a) a company resident in the United Kingdom (the transferor) transfers to a company resident in another Member State (the transferee) the whole or part of a business which, immediately before the time of the transfer, the transferor carried on in a Member State other than the United Kingdom through a permanent establishment; (b) the transfer includes the whole of the assets of the transferor used for the purposes of the business or part (or the whole of those assets other than cash); (c)

the transfer is wholly or partly in exchange for shares or debentures issued by the transferee to the transferor;

(d) the aggregate of the chargeable gains accruing to the transferor on the transfer exceeds the aggregate of the allowable losses so accruing; (e)

a claim is made under this section by the transferor; and

(f)

section 140D does not prevent this section applying.’

Analysis 28.15 This provision is also intended to permit transfers of assets, as defined by the Mergers Directive. In this case, however, we are looking at the

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28.15 EU branch incorporations incorporation of a non-UK business carried on by a UK resident company into a company resident in another Member State (ie not the UK). It is necessary to understand what the ‘business’ is in practice, and whether this has been adequately reflected by the relevant legal documentation. Given the cross-border nature of this type of demerger, it will be necessary to ensure that the transfer is documented and effected to meet the requirements of the relevant tax and corporate law requirements in the UK and each relevant jurisdiction, being the jurisdiction in which the transferee is resident and the jurisdiction in which the permanent establishment is located, to the extent these are different. An example of where there can be a potential disconnect is where there is a local requirement to have a local transfer agreement for certain assets whilst the transfer is documented under a broader business transfer agreement. In these circumstances, it will be necessary to ensure that the combination of these agreements constitutes a single arrangement to transfer the relevant business, rather than a set of stand-alone agreements to transfer separate baskets of assets. To allow TCGA 1992, s 140C to operate in a post-Brexit environment, the word ‘a’ has been replaced with ‘another’ and the words ‘other than the United Kingdom’ have been repealed by SI 2019/689 from the ‘exit day’ (being the day of Brexit) to allow this provision to continue to apply as before. The effect of this amendment is to prevent TCGA 1992, s 140C from being broadened to apply to transfers to companies outside the EU. TCGA 1992, s 140C(1) sets out the conditions to be satisfied before the relief can be claimed. A UK transferor company must transfer a business or part of a business carried on outside the UK through a permanent establishment to a transferee company resident in another Member State. Once again, we notice the change from trade to business from 1 January 2007. This permits the transfer of a trade to a company resident in the same Member State as the permanent establishment or to a company resident in another Member State. Figure 28.2 shows transactions to which TCGA 1992, s 140C might apply. In both examples, UK Co is the transferor and the transferee is the German or Spanish company, as appropriate. The point to note here is that the non-UK PE can be incorporated into a company resident in an EU Member State. There is no requirement that, say, a German PE can only be incorporated into a German company.

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EU branch incorporations 28.15 Figure 28.2

A transaction not covered by this relief is the transfer of the business of a non-UK permanent establishment to a UK resident company. However, in such a case, both the transferor and transferee companies are UK resident and TCGA 1992, s 171 would apply to the transaction. The assets transferred must comprise all the assets of that business or part business, although the cash can be retained. So far, this is very similar to TCGA 1992, s 140. The transfer must be wholly or partly for shares and debentures, which is different from TCGA 1992, s 140A, where the consideration must be wholly for shares or debentures. Also, in contrast to TCGA 1992, s 140, there is no restriction to the relief under TCGA 1992, s 140C where the consideration is only partly in the form of securities, nor is there a 25 per cent shareholding requirement in TCGA 1992, s 140C.

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28.16 EU branch incorporations As for TCGA 1992, s 140, there must be an aggregate gain after deducting any allowable losses that accrue on the disposals. The relief only applies to that aggregate gain. The relief must be claimed, but only by the transferor company. So the UK corporation tax provisions relating to claims will apply to TCGA 1992, s 140C. The relief is subject to the anti-avoidance provisions of TCGA 1992, s 140D. Subsequent disposals of assets or of shares or debentures 28.16 Again, it is appropriate to consider what happens if either the assets or the shares or debentures are subsequently sold. The result of a TCGA 1992, s 140C transaction is that the assets are owned by a non-UK resident company, so the consequences of a disposal of the assets are a matter for local tax law in the appropriate country and no postponed tax charge is applied to the original transferor company. While TCGA 1992, ss 140 and 140C have many similarities (see the next section), there are no provisions under TCGA 1992, s 140C corresponding to the claw-back of the relief by TCGA 1992, s 140 on a sale of the assets (within six years) or of the shares or other securities of the transferee, whenever that might occur. This is why the relief is often seen as akin to a quasi-exemption. The UK transferor company in a TCGA 1992, s 140C transaction will own shares and possibly debentures of the transferee company. Any disposal of the shares by the transferor company will, we assume, be taxed under normal UK principles, including the application of the substantial shareholding exemption if appropriate. There is no TCGA 1992, s 179 charge in respect of the assets held by the transferee company as it is not a UK resident company at the time of the acquisition (so failing the condition at TCGA 1992, s 179(1A)(a)). And, of course, it is possible that some tax will already have been charged to the transferor company under TCGA 1992, s 140C(3). If there is a disposal of debentures of the transferee company, we assume, again, that the debentures would be qualifying corporate bonds outside the scope of taxation of chargeable gains by TCGA 1992, s 115. TCGA 1992, s 140C(2), (3) and (5) – mechanism of relief 28.17 ‘(2) In a case where this section applies, this Act shall have effect in accordance with subsection (3) below.

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EU branch incorporations 28.21 (3) The allowable losses accruing to the transferor on the transfer shall be set off against the chargeable gains so accruing and the transfer shall be treated as giving rise to a single chargeable gain equal to the aggregate of those gains after deducting the aggregate of those losses. (5) In a case where this section applies, section 122 TIOPA 2010 shall also apply.’1

1 The legislation as published refers to ICTA 1988, s 815A. But this provision has been repealed and replaced by TIOPA 2010, s 122. It appears that a drafting error means that neither TCGA 1992, s 140C(5) nor TCGA 1992, s 140F(4) has been amended.

Analysis 28.18 As we have already seen with TCGA 1992, s 140, which has similarities to TCGA 1992, s 140C, the relief applies to the net aggregate gain arising from the disposals of the assets. Once the single chargeable gain postulated by TCGA 1992, s 140C(3) has been computed, the double taxation provisions of TIOPA 2010, s 122 are applied. Essentially, TIOPA 2010, s 122 tells us to compute the tax that would have been charged on the disposal of the assets in the country where the permanent establishment resided. This is done on the assumption that the Mergers Directive does not apply. This mechanism is discussed in further detail in Chapters 26 and 27 and, in particular, what could be considered ‘but for the Mergers Directive’ for the purposes of TIOPA 2010, s 122. TCGA 1992, s 140C(4) – no double relief 28.19 ‘(4) No claim may be made under this section as regards a transfer in relation to which a claim is made under section 140.’ Analysis 28.20 This provides that relief cannot be given under both TCGA 1992, ss 140 and 140C. TCGA 1992, s 140 was analysed in Chapter 27.

TCGA 1992, s 140D – anti-avoidance 28.21 ‘(1) Section 140C shall not apply unless the transfer of the business or part is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the 663

28.22 EU branch incorporations main purposes, is avoidance of liability to income tax, corporation tax or capital gains tax. (2) Subsection (1) above shall not apply where, before the transfer, the Board have on the application of the transferor notified that company that the Board are satisfied that the transfer will be effected for bona fide commercial reasons and will not form part of any such scheme or arrangements as are mentioned in that subsection. (3) Subsections (2) to (5) of section 138 shall have effect in relation to subsection (2) above as they have effect in relation to subsection (1) of that section.’ Analysis 28.22 This provision is almost identical to TCGA 1992, s 140B and the same comments apply.

Comparison of TCGA 1992, ss 140 and 140C 28.23 TCGA 1992, ss 140 and 140C are very similar in structure and scope, so it is worth having a look at the similarities and differences between them. Broadly, both provide for the reduction of the tax charge when a UK company incorporates a permanent establishment in another jurisdiction. With TCGA 1992, s 140, this is only a deferral (albeit potentially a permanent deferral) until the shares in the transferee company are sold, while TCGA 1992, s 140C provides a permanent reduction in the tax charge, as there is no subsequent claw-back if the transferee company is sold. The effect of this reduction in the tax charge is of course dependent on the level of taxes paid overseas and the extent to which the relieving provisions in the relevant EU Member State implement the Mergers Directive. TCGA 1992, s 140C is restricted to cases where the permanent establishment and the transferee company are in the EU. TCGA 1992, s 140 is available without regard to the locations of either the permanent establishment or the transferee company. But TCGA 1992, s 140C is now less restrictive in that the permanent establishment is only required to carry on a business, whereas in TCGA 1992, s 140 it must be trading, a matter that has given the authors a great deal of difficulty over the years. TCGA 1992, s 140 has the more restrictive requirements in terms of the securities issued by the transferee company. Under TCGA 1992, s 140, the transferor must hold 25 per cent of the shares of the transferee after the transaction. There is no such requirement in TCGA 1992, s 140C. Also, while 664

EU branch incorporations 28.25 neither requires the whole of the consideration to be in the form of securities, only TCGA 1992, s 140 restricts relief for non-security consideration. TCGA 1992, s 140 brings the tax charge back into play where there is a sale of the assets within six years of the incorporation or at any time if the shares or other securities of the transferee are sold (or otherwise disposed of). There are no corresponding provisions under TCGA 1992, s 140C. While both reliefs have to be claimed, a degree of comfort is available by way of clearance from HMRC that the TCGA 1992, s 140C transaction is carried out for bona fide commercial reasons and not to avoid tax. Conversely, there is no requirement in TCGA 1992, s 140 that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax. Another interesting point, though one that may be of limited relevance depending on the outcome of Brexit negotiations, is that TCGA 1992, s 140C provides the taxpayer with added EU protection which cannot be afforded under TCGA 1992, s 140. Put another way, if a taxpayer considers that TCGA 1992, s 140C ought to apply as a result of the application of the Mergers Directive but HMRC considers otherwise, the taxpayer could be able to pursue whether this outcome is contrary to EU law. In conclusion, both reliefs are potentially useful although they operate in different ways. TCGA 1992, s 140 is of wider geographical application, but has more onerous claw-back provisions. In the final analysis, the decision as to which relief to claim will depend on the commercial requirements of the companies concerned.

Securities issued on division of business 28.24 TCGA 1992, ss 140A and 140C provide for exemptions or deferral from tax for the companies involved in a partial division. But neither of them provide for any protection for shareholders, who might otherwise be treated as disposing of some or all of the shares they hold in a transferor company. To put the matter beyond doubt, the regulations introduce TCGA 1992, s 140DA, which ensures that the transactions are treated as if they are a scheme of reconstruction, even if they are not. TCGA 1992, s 140DA is discussed in detail in Chapter 26.

FURTHER RELIEFS FOR CROSS-BORDER DEMERGERS 28.25 There are provisions in respect of loan relationships, derivative contracts and intangible fixed assets equivalent to those for chargeable assets 665

28.26 EU branch incorporations in TCGA 1992, ss 140A(1) and 140C(1). The TCGA 1992, s 140A equivalents are in various parts of CTA 2009. The provisions equivalent to TCGA 1992, s 140C are contained in TIOPA 2010, ss 116 and 117, which apply to loan relationships, derivative contracts and intangible fixed assets.

Provisions equivalent to TCGA 1992, s 140A Intangible fixed assets 28.26 The legislation is in CTA 2009, Part 8, Chapter 11. The description of the relevant demerger transactions in CTA 2009, s 819(2) is almost identical to that at TCGA 1992, s 140A(1). CTA 2009, s 820 tells us that such a transfer is to be ‘tax neutral’, so long as the intangible fixed assets that are chargeable intangible assets to both the transferor and the transferee, so that the assets are within the scope of UK corporation tax both before and after the transaction. This means that the transferor is not treated as having realised the intangible fixed asset and the transferee is treated as standing in the shoes of the transferor as ‘having held the asset at all times when it was held by the transferor and as having done all such things in relation to the asset as were done by the transferor’ (CTA 2009, s 776). This is broadly equivalent to the no gain, no loss provision in TCGA 1992, s 140A. CTA 2009, ss 831–833 cover the requirement that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax and make provision for pre-transaction clearances. It is interesting to note that CTA 2009, s 819(4) and (5) retain provisions relating to company residence, even though the equivalent provisions in TCGA 1992, s 140A have been repealed. And there is no provision preventing double relief under CTA 2009, ss 818 (equivalent to TCGA 1992, s 139) and 819, although it is difficult to see what impact such double relief would actually have, in any case.

Loan relationships 28.27 The legislation is in CTA 2009, Part 5, Chapter 13. The description of the relevant demerger transactions in CTA 2009, s 421(3) is almost identical to that at TCGA 1992, s 140A(1). CTA 2009, s 422 generally applies where a loan relationship is transferred as part of the business transfer and the transferee is within the charge to UK corporation tax. Such transfers are treated as being carried out at the notional carrying value of the loan relationship, which is equivalent to its tax adjusted 666

EU branch incorporations 28.28 carrying value based on the accounts of the transferor if a period of account had ended immediately before the date when the transferor ceased to be a party to the loan relationship. However, under CTA 2009, s 423, if the transferor company uses fair value accounting, the transfer is treated as being at fair value, which may generate a tax liability, although, in practice, this would usually mean that the loan relationship is taxed on a ‘mark-to-market’ basis and, as such, the merger itself has not technically given rise to the tax charge. CTA 2009, ss 426–428 also require that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax, and they make provision for pre-transaction clearances. There is also a regime TAAR which applies to the loan relationship regime (see CTA 2009, s 455B et seq) which should be considered. Generally, though, we would expect these to be commercial transactions, so that the TAAR would not be in point.

Derivative contracts 28.28 The legislation is in CTA 2009, Part 7, Chapter 9. The description of the relevant demerger transactions in CTA 2009, s 674(2) is almost identical to that at TCGA 1992, s 140A(1). CTA 2009, s 675 generally applies where a derivative contract is transferred as part of the business transfer and the transferee is within the charge to UK corporation tax. Such transfers are treated as being carried out at the notional carrying value of the loan relationship, which is equivalent to its tax adjusted carrying value based on the accounts of the transferor if a period of account had ended immediately before the date when the transferor ceased to be a party to the loan relationship. However, under CTA 2009, s 676, if the transferor company uses fair value accounting, the transfer is treated as being at fair value, which may generate a tax liability, although, in practice, this would usually mean that the derivative contract is taxed on a ‘mark-to-market’ basis and, as such, the merger itself has not technically given rise to the tax charge. CTA 2009, ss 677–679 also require that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax and make provision for pre-transaction clearances. There is also a regime TAAR which applies to the derivative contracts regime (see CTA 2009, s 698A et seq) which should be considered. Generally, though, we would expect these to be commercial transactions, so that the TAAR would not be in point.

667

28.29 EU branch incorporations

Provisions equivalent to TCGA 1992, s 140C 28.29 As noted above, the provisions equivalent to TCGA 1992, s 140C for loan relationships, derivative contracts and intangible fixed assets are in TIOPA 2010, ss 116 and 117. TIOPA 2010, s 116(2) describes transactions almost identical to those referred to in TCGA 1992, s 140C(1). And TIOPA 2010, s 117 broadly gives an identical relief, by giving credit against the disposal gain for the tax that would have been paid in the other Member State but for the application of the Mergers Directive. TIOPA 2010, s 117(3)–(6) require that the transaction be carried out for bona fide commercial reasons and not for the avoidance of tax and make provision for pre-transaction clearances.

CONCLUSION – BRANCH INCORPORATIONS 28.30 It is interesting to see the different approaches for the incorporation of non-UK branches in TCGA 1992, ss 140 and 140C, which were enacted at very different times and for different reasons. TCGA 1992, ss 140A–140D were enacted in 1992 (originally) to comply with the EU Mergers Directive, while safeguarding the UK tax base with appropriate anti-avoidance legislation. So what we see is a mixture of the old and the new, with the basic rules in TCGA 1992, ss 140A and 140C reflecting the requirements of the relatively recent Mergers Directive, and TCGA 1992, ss 140B and 140D being very much in the mould of the long-standing approach to tax avoidance, the requirement for commercial reasons and the facility for pre-transaction clearances that have been around in the UK tax code since at least 1960.

STAMP TAXES 28.31 As previously noted, the cross-border nature of a transaction should, in principle, have no effect on the stamp tax consequences. Prior to 2006, stamp duty reconstruction relief and relief for acquisition of shares under FA 1986, ss 75 and 77 required that the new acquiring company have a UK registered office. This was clearly discriminatory and this condition was removed from July 2006.

668

EU branch incorporations 28.33

VALUE ADDED TAX Incorporation of overseas branch 28.32 The VAT position is exactly the same as in the case of a branch incorporation under TCGA 1992, s 140, and is explained at 27.32.

Incorporation of UK branch 28.33 Here the trade or part trade is being carried on in the UK. The transferor, even if overseas resident, will, if the trade is the making of taxable supplies, be registered for UK VAT and the transferee will be registered or become registrable for UK VAT. Ordinarily the exercise will be a TOGC under the UK TOGC rules, for which see 23.26. It must be remembered that, if the transferor is registered, the transferee must already be registered or become compulsorily registrable or be accepted by HMRC before the transaction for voluntary registration. If the exercise qualifies as a TOGC, the transferor’s input VAT on its costs of the exercise will relate to the underlying activities of the trade or part trade and, if those are taxable, its input VAT will be recoverable: see 23.26. Occasionally there may be a complicating factor, for example, where some assets of the trade or part trade are situated in another country, see, for example, 26.63 above. The transferee company makes no supply as a result of the exercise, and whether it is entitled to a refund of its input VAT on its costs will relate to the activities of the trade or part trade being acquired. If those activities are taxable, the transferee will be entitled to a refund.

669

670

Index

[All references are to paragraph numbers] Accelerated payment notices generally, 1.66 Acquisition relief stamp duty land tax, and, 2.18 stamp duty (reserve tax), and anti-avoidance, 2.14 generally, 2.11 insertion of new holding company, 2.12 introduction, 2.10 territorial scope, 2.13 Advance clearance appeal against Board’s decision, 14.11–14.12 applicants, 14.6 applications applicants, 14.6 chasing, 14.15 form, 14.7–14.8 timing, 14.16 urgent, 14.17 Board’s obligation, 14.9–14.10 company reconstruction relief, and, 18.26–18.27 conclusion, 14.19 cross-border mergers, and mergers leaving assets outside UK tax charge, 20.44–20.45 mergers leaving assets within UK tax charge, 20.29–20.30 shareholder relief, 20.56–20.58 effect, 14.2–14.3 form of application, 14.7–14.8 intangible fixed assets relief, and, 18.41–18.42 introduction, 14.1 legislative background appeal against Board’s decision, 14.11–14.12 Board’s obligation, 14.9–14.10 effect, 14.2–14.3

Advance clearance – contd legislative background – contd form of application, 14.7–14.8 voiding decisions, 14.13–14.14 obligation of the Board, 14.9–14.10 practical issues, 14.15–14.17 reconstructions, and company reconstruction relief, 18.26–18.27 intangible fixed assets relief, 18.41–18.42 scope, 14.4 stamp taxes, 14.20 timing of applications, 14.16 urgent applications, 14.17 value added tax, 14.21 voiding decisions, 14.13–14.14 Allowable losses capital gains tax, and, 1.7 Amalgamations see also Mergers generally, 9.3 Anti-avoidance see also Anti-avoidance (reconstructions) accelerated payment notices, 1.66 background, 1.57 cash-flow benefit accelerated payment notices, 1.66 follower notices, 1.65 generally, 1.64 conclusion, 1.68 current position, 1.58 disclosure of tax avoidance schemes, 1.59 earn-outs, and election out, 10.6–10.7 generally, 10.4–10.7 follower notices, 1.65 general anti-abuse rule (GAAR) Advisory Panel, 1.62

671

Index Anti-avoidance – contd general anti-abuse rule (GAAR) – contd background, 1.60 general, 1.61 guidance, 1.63 introduction, 1.56 Land and Buildings Transaction Tax, 2.25 Land Transaction Tax, 2.30 Ramsay doctrine generally, 1.67 reconstructions, 13.1 substantial shareholding exemption, 1.21 reconstructions, and bona fide commercial reason test, 13.9 conclusion, 13.23 ‘corporation tax’, 13.18 Craven v White decision, 13.4 Floor v Davis decision, 13.2 Furniss v Dawson decision, 13.3 introduction, 13.1 legislative background, 13.6–13.22 main purpose, 13.11 motivation, 13.16 persons affected, 13.17 principal test, 13.7–13.18 Ramsay doctrine, 13.1 restricted application of provisions, 13.19–13.20 ‘tax advantage’, 13.10 third party liabilities, 13.21–13.22 removal of tax cash-flow benefit accelerated payment notices, 1.66 follower notices, 1.65 generally, 1.64 share-for-share exchanges, and, 8.17–8.18 stamp duty, 2.1 stamp duty land tax, and clawback of reliefs, 2.21 denial of reliefs, 2.20 disclosure of tax avoidance schemes, 2.22 general rules, 2.19 stamp duty reserve tax, 2.14

Anti-avoidance – contd statutory rules background, 1.57 conclusion, 1.68 current position, 1.58 disclosure of tax avoidance schemes, 1.59 general anti-abuse rule, 1.60–1.63 Ramsay doctrine, 1.67 removal of tax cash-flow benefit, 1.64–1.66 substantial shareholding exemption, and generally, 1.24 Ramsay doctrine, 1.67 transfer of UK trade, and, 28.12–28.13 Anti-avoidance (reconstructions) bona fide commercial reason test generally, 13.9 recent case law, 13.13 conclusion, 13.23 ‘corporation tax’, 13.18 Craven v White decision, 13.4 Floor v Davis decision, 13.2 Furniss v Dawson decision, 13.3 introduction, 13.1 legislative background introduction, 13.6 principal test, 13.7–13.18 restricted application of provisions, 13.19–13.20 third party liabilities, 13.21–13.22 main purpose, 13.11 motivation, 13.16 persons affected, 13.17 principal test bona fide commercial reason test, 13.9 ‘corporation tax’, 13.18 generally, 13.7–13.8 main purpose, 13.11 motivation, 13.16 persons affected, 13.17 Snell v HMRC, 13.12–13.15 ‘tax advantage’, 13.10 Ramsay doctrine, 13.1 restricted application of provisions, 13.19–13.20 ‘tax advantage’, 13.10 third party liabilities, 13.21–13.22

672

Index Appeals clearances, and, 14.11–14.12 Apportionment of consideration reorganisation of share capital, and, 6.22–6.23 Arrangements with members applications, 17.2 benefits of use of CA 2006, Part 26, 17.3 CA 2006, ss 895 and 899, and, 17.2 CA 2006, s 900, and, 17.5 conclusions, 17.6 court sanction, 17.2 introduction, 17.1 powers of court to facilitate, 17.5 stamp taxes, 17.11 value added tax, and buyer’s position, 17.9 introduction, 17.7 seller’s position, 17.8 target’s position, 17.10 when use of CA 2006, Part 26 is not required, 17.4 Balancing charges liquidation distribution, and, 23.16 return of capital’ demergers, and, 25.24 Bona fide commercial reason anti-avoidance, and generally, 13.9 recent case law, 13.13 cross-border mergers, and mergers leaving assets outside UK tax charge, 20.44–20.45 mergers leaving assets within UK tax charge, 20.29–20.30 shareholder relief, 20.56–20.58 reconstructions, and company reconstruction relief, 18.26–18.27 shareholder reconstruction relief, 18.13 Bonds conversion of securities, and, 7.2 Bonus issues increase in share capital, and, 6.9 Branch incorporations see also EU branch incorporations application of relief, 27.10–27.11

Branch incorporations – contd background, 27.3 basic conditions, 27.6–27.7 claim by transferor company, 27.8–27.9 comparison with TCGA, s 140C, 28.23 conclusion, 27.30 disposal of assets, 27.14–27.15 disposal of securities, 27.12–27.13 exceptions from charge, 27.16–27.19 exceptions for mergers, 27.24–27.25 foreign permanent establishment exception, 27.2 intangible fixed assets, and, 27.28–27.29 interaction with Mergers Directive reliefs, 27.22–27.23 intra-group transactions, 27.17 introduction, 27.1 legislative basis, 27.5 modernisation of relief, 27.4 replication of previous provisions, 27.26–27.27 restriction on double relief, 27.20–27.21 stamp taxes, 27.31 value added tax, 27.32 Business separations reconstructions, and, 16.14–16.15 Capital allowances liquidation distribution, and, 23.16 return of capital’ demergers, and, 25.24 Capital gains allowable losses, 1.7 background, 1.3 conclusion, 1.4 degrouping charge, 1.10 ‘Dutch participation’ exemption, and, 1.11 Enterprise Investment Scheme, and deferral relief, 10.5–10.10 disposal relief, 10.4 group relationship rules Gallaher decision, 1.9 generally, 1.8 introduction, 1.6

673

Index Capital gains – contd substantial shareholding exemption anti-avoidance, 1.24 extensions, 1.21–1.23 ‘group’, 1.19 interaction with overseas taxes, 1.26 introduction, 1.11 investee company requirements, 1.15–1.18 investing company requirements, 1.14 recent reforms, 1.18 relief, 1.12 requirement, 1.13 scope, 1.25 ‘trading’, 1.16 transfer of trading assets, 1.17 Cash payments conversion of securities, and, 7.11–7.12 Change in economic ownership stamp duty (reserve tax), and, 2.10 Chargeable gains intangible fixed assets relief, and, 18.43 Chargeable payments anti-avoidance, and, 24.34 basic charge, 24.51–24.52 ‘company concerned in an exempt distribution’, 24.61–24.62 ‘connected’, 24.62 definition, 24.55–24.56 generally, 24.50 not deductible in calculating profits, 24.53–24.54 practical advice, 24.63 unquoted companies, and, 24.57–24.60 Clearances appeal against Board’s decision, 14.11–14.12 applicants, 14.6 applications applicants, 14.6 chasing, 14.15 form, 14.7–14.8 timing, 14.16 urgent, 14.17 Board’s obligation, 14.9–14.10 company reconstruction relief, and, 18.26–18.27

Clearances – contd conclusion, 14.19 cross-border mergers, and mergers leaving assets outside UK tax charge, 20.44–20.45 mergers leaving assets within UK tax charge, 20.29–20.30 shareholder relief, 20.56–20.58 effect, 14.2–14.3 form of application, 14.7–14.8 intangible fixed assets relief, and, 18.41–18.42 introduction, 14.1 legislative background appeal against Board’s decision, 14.11–14.12 Board’s obligation, 14.9–14.10 effect, 14.2–14.3 form of application, 14.7–14.8 voiding decisions, 14.13–14.14 obligation of the Board, 14.9–14.10 practical issues, 14.15–14.17 reconstructions, and company reconstruction relief, 18.26–18.27 intangible fixed assets relief, 18.41–18.42 scope, 14.4 stamp taxes, 14.20 timing of applications, 14.16 urgent applications, 14.17 value added tax, 14.21 voiding decisions, 14.13–14.14 Collection of unpaid tax company reconstruction relief, and, 18.28–18.29 Combination of companies see also Mergers generally, 9.3 Commercial transactions mergers, and, 19.12 Company compromises or arrangements with members applications, 17.2 benefits of use of CA 2006, Part 26, 17.3 CA 2006, ss 895 and 899, and, 17.2 CA 2006, s 900, and, 17.5 conclusions, 17.6 court sanction, 17.2

674

Index Company compromises or arrangements with members – contd introduction, 17.1 powers of court to facilitate, 17.5 stamp taxes, 17.11 value added tax, and buyer’s position, 17.9 introduction, 17.7 seller’s position, 17.8 target’s position, 17.10 when use of CA 2006, Part 26 is not required, 17.4 Company reconstruction relief (TCGA, s 139) basic relief, 18.17–18.18 bona fide commercial reason, 18.26–18.27 clearances, 18.26–18.27 collection of unpaid tax, 18.28–18.29 company law issues, 18.15–18.16 definitions, 18.30–18.31 degrouping charge, 18.22–18.23 exclusions from relief, 18.24–18.25 introduction, 15.4 pre-transaction clearances and, 18.26–18.27 purpose, 18.15 scope of relief, 18.20–18.21 stamp duty, 18.45 substantial shareholding exemption, and, 18.19 value added tax, 18.46 Compensation stock conversion of securities, and, 7.13–7.14 Composite new holdings reorganisation of share capital, and, 6.24–6.25 Compromises with members applications, 17.2 benefits of use of CA 2006, Part 26, 17.3 CA 2006, ss 895 and 899, and, 17.2 CA 2006, s 900, and, 17.5 conclusions, 17.6 court sanction, 17.2 introduction, 17.1 powers of court to facilitate, 17.5 stamp taxes, 17.11

Compromises with members – contd value added tax, and buyer’s position, 17.9 introduction, 17.7 seller’s position, 17.8 target’s position, 17.10 when use of CA 2006, Part 26 is not required, 17.4 Consideration generally, 9.5 stamp duty land tax, and generally, 2.16 non-market value, 2.17 stamp duty (reserve tax), and, 2.7 Consideration given conversion into qualifying corporate bonds, and, 9.19–9.20 reorganisation of share capital, and, 6.20–6.21 Consideration received conversion into qualifying corporate bonds, and basic approach, 9.17–9.18 more complex approach, 9.29–9.30 QCBs, and, 9.31–9.32 reorganisation of share capital, and, 6.20–6.21 Continuity of business ‘business separations’, 16.14–16.15 group companies, 16.16–16.17 introduction, 16.9 more than one original company, 16.12–16.13 one original company, 16.10–16.11 winding up, etc, and, 16.18–16.19 Conversion into qualifying corporate bonds conclusion, 9.36 consideration given, 9.19–9.20 consideration received basic approach, 9.17–9.18 more complex approach, 9.29–9.30 QCBs, and, 9.31–9.32 definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 earn-outs, and, 10.18 examples, 9.35 exemptions, 9.27–9.28 introduction, 9.1

675

Index Conversion into qualifying corporate bonds – contd legislative background consideration given, 9.19–9.20 consideration received, 9.17–9.18 definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 exemptions, 9.27–9.28 introduction, 9.6 loan relationships, and, 9.21–9.22 new assets, 9.25–9.26 old assets, 9.23–9.24 priority over loan relationship rules, 9.33–9.34 scope of provisions, 9.7–9.10 taxation of consideration received, 9.29–9.32 loan relationships rules, and generally, 9.21–9.22 priority, 9.33–9.34 meaning of ‘qualifying corporate bonds’, 9.2 new assets, 9.25–9.26 old assets, 9.23–9.24 scope of provisions, 9.7–9.10 stamp taxes, and, 9.37 substantial shareholding exemption, and, 11.6–11.7 value added tax, and, 9.38 Conversion of securities cash payments received, 7.11–7.12 compensation stock, 7.13–7.14 conclusion, 7.15 definition, 7.5–7.6 definition of ‘security’ generally, 7.5–7.6 introduction, 7.2 general treatment, 7.3–7.4 introduction, 7.1 legislative background cash payments received, 7.11–7.12 compensation stock, 7.13–7.14 definitions, 7.5–7.8 general treatment, 7.3–7.4 premiums, 7.9–7.10 premiums, 7.9–7.10 stamp taxes, and, 7.16

Conversion of securities – contd value added tax, and company’s position, 7.19 introduction, 7.17 securities-holder position, 7.18 Corporate Venturing Scheme generally, 12.19 Corporation tax basic rules, 1.5 capital allowances, 1.55 capital gains, and see also Capital gains allowable losses, 1.7 background, 1.3 conclusion, 1.4 degrouping charge, 1.10 group relationship rules, 1.8–1.9 introduction, 1.6 substantial shareholding exemption, 1.11–1.26 conclusion, 1.4 credits and debits to be brought into account derivative contracts, 1.51 loan relationships, 1.40 demergers, and, 21.2 derivative contracts, and credits and debits to be brought into account, 1.51 definition, 1.49 general overview, 1.48 introduction, 1.47 presentation of accounts, 1.53 relevant matters, 1.50 tax qualifications, 1.52 transfer within groups, 1.54 ‘follow the accounts’ approach, 1.40 generally, 1.2 intangible fixed assets, and see also Intangible fixed assets commencement of code, 1.29 deemed realisations, 1.32 definition, 1.30 general rule, 1.29 group transfers between UK companies, 1.34 ‘intangible asset’, 1.30 introduction, 1.27–1.28

676

Index Corporation tax – contd intangible fixed assets, and – contd realisations, 1.31–1.34 related party transfers, 1.33 loan relationships, and connected companies relationships, 1.43 credits and debits to be brought into account, 1.40 definition, 1.38 ‘follow the accounts’ approach, 1.40 general overview, 1.37 introduction, 1.36 ‘money debt’, 1.38 presentation of accounts, 1.42 relevant matters, 1.39 tax qualifications, 1.41 transfer within groups, 1.44–1.46 presentation of accounts derivative contracts, 1.53 loan relationships, 1.42 tax qualifications derivative contracts, 1.52 loan relationships, 1.41 transfers within groups derivative contracts, 1.54 loan relationships, 1.44–1.46 Creditor reconstruction relief (TCGA, s 136) generally, 18.2–18.14 introduction, 15.4 Cross-Border Conversion Directive 2019/2121 generally, 4.15 Cross-border mergers see also EU cross-border demergers conclusions, 20.65 consequential amendments, 20.64 derivatives mergers leaving assets within UK tax charge, 20.36 Directive 2005/56/EC introduction, 4.25 Sevic case, 4.26 UK implementation, 4.27 distributions, 20.61–20.63 enabling legislation definitions, 20.10–20.11 restriction of scope of regulations, 20.8–20.9

Cross-border mergers – contd enabling legislation – contd scope of existing legislation to which regulations can apply, 20.6–20.7 scope of transaction to which regulations can apply, 20.4–20.5 European Company Statute, and, 20.1 FA 2007, s 110 definitions, 20.10–20.11 restriction of scope of regulations, 20.8–20.9 scope of existing legislation to which regulations can apply, 20.6–20.7 scope of transaction to which regulations can apply, 20.4–20.5 intangible fixed assets mergers leaving assets outside UK tax charge, 20.46 mergers leaving assets within UK tax charge, 20.34 introduction, 20.1 legal background enabling legislation, 20.4–20.12 FA 2007, s 110, 20.4–20.11 generally, 20.3 legislation, 20.13 Regulations, 20.12 loan relationships mergers leaving assets within UK tax charge, 20.35 ‘merger’, 20.2 mergers leaving assets outside UK tax charge (TCGA, s 140F) bona fide commercial reasons, 20.44–20.45 clearances, 20.44–20.45 conditions for legislation to apply, 20.40–20.41 effect of legislation, 20.44–20.45 generally, 20.37 introduction, 20.13 mechanism of relief, 20.42–20.43 scope of legislation, 20.38–20.39 tax avoidance test, 20.44–20.45

677

Index Cross-border mergers – contd mergers leaving assets within UK tax charge (TCGA, s 140E) bona fide commercial reasons, 20.29–20.30 conditions for legislation to apply, 20.21–20.22 consequential changes, 20.27–20.28 definitions, 20.31–20.32 effect of legislation, 20.23–20.24 generally, 20.14 introduction, 20.13 qualifying transferred asset, 20.25–20.26 scope of legislation, 20.15–20.20 tax avoidance test, 20.29–20.30 relevant transactions, 20.2 Sevic case, 4.26 shareholder relief (TCGA, s 140G) bona fide commercial reasons, 20.56–20.58 clearances, 20.56–20.58 effect of legislation, 20.52–20.53 generally, 20.47 introduction, 20.13 qualifying conditions, 20.50–20.51 qualifying mergers, 20.48–20.49 restrictions of relief, 20.54–20.55 stamp taxes, 20.66 subsidiary merges with its parent (TCGA, s 140GA), 20.59–20.60 UK Regulations, 20.12 value added tax, 20.67 Debentures conversion of securities, and, 7.2 share-for-share exchanges, and, 8.1 ‘Debt on a security’ conversion of securities, and, 7.2 Deemed reorganisations anti-avoidance bona fide commercial reason test, 13.9 conclusion, 13.23 ‘corporation tax’, 13.18 Craven v White decision, 13.4 Floor v Davis decision, 13.2 Furniss v Dawson decision, 13.3 introduction, 13.1 legislative background, 13.6–13.22

Deemed reorganisations – contd anti-avoidance – contd main purpose, 13.11 motivation, 13.16 persons affected, 13.17 principal test, 13.7–13.18 Snell v HMRC, 13.12–13.15 restricted application of provisions, 13.19–13.20 ‘tax advantage’, 13.10 third party liabilities, 13.21–13.22 clearances acknowledgment, 14.15 appeal against Board’s decision, 14.11–14.12 applicants, 14.6 applications, 14.7–14.8, 14.15–14.17 Board’s obligation, 14.9–14.10 conclusion, 14.19 effect, 14.2–14.3 form of application, 14.7–14.8 introduction, 14.1 legislative background, 14.2–14.14 obligation of the Board, 14.9–14.10 practical issues, 14.15–14.17 scope, 14.4 stamp taxes, 14.20 technical conditions, 14.5 timing of applications, 14.16 urgent applications, 14.17 value added tax, 14.21 voiding decisions, 14.13–14.14 conversion of shares into QCBs conclusion, 9.36 consideration given, 9.19–9.20 consideration received, 9.17–9.18 definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 examples, 9.35 exemptions, 9.27–9.28 introduction, 9.1 legislative background, 9.6–9.34 loan relationships, and, 9.21–9.22 meaning of ‘qualifying corporate bonds’, 9.2 new assets, 9.25–9.26 old assets, 9.23–9.24

678

Index Deemed reorganisations – contd conversion of shares into QCBs – contd priority over loan relationship rules, 9.33–9.34 scope of provisions, 9.7–9.10 stamp taxes, and, 9.37 taxation of consideration received, 9.29–9.32 value added tax, and, 9.38 Corporate Venturing Scheme, 12.19 earn-outs avoidance condition, 10.4–10.7 conclusion, 10.20 consequences of treatment, 10.8–10.9 election out, 10.6–10.7, 10.12–10.15 employment-related securities legislation, and, 10.19 introduction, 10.1 legislative background, 10.2–10.17 meaning, 10.2–10.3 QCB rules, and, 10.18 replacement of right, 10.10–10.13 stamp taxes, 10.21 ‘unascertainable’, 10.16–10.177 value added tax, and, 10.22 Enterprise Investment Scheme capital gains tax relief, 12.4–12.5 deferral relief, 12.5–12.9 disposal relief, 12.4 income tax relief, 12.3 introduction, 12.2 introduction, 8.1 investment schemes, and conclusion, 12.21 Corporate Venturing Scheme, 12.19 Enterprise Investment Scheme, 12.2–12.9 introduction, 12.1 investors’ relief, 12.20 Venture Capital Trusts, 12.14–12.19 non-QCBs currency conversion, 9.5 introduction, 9.3 normal commercial loan, 9.4 purpose of legislation, 8.2 QCB conversion conclusion, 9.36 consideration given, 9.19–9.20 consideration received, 9.17–9.18

Deemed reorganisations – contd QCB conversion – contd definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 examples, 9.35 exemptions, 9.27–9.28 introduction, 9.1 legislative background, 9.6–9.34 loan relationships, and, 9.21–9.22 meaning of ‘qualifying corporate bonds’, 9.2 new assets, 9.25–9.26 old assets, 9.23–9.24 priority over loan relationship rules, 9.33–9.34 scope of provisions, 9.7–9.10 stamp taxes, and, 9.37 taxation of consideration received, 9.29–9.32 value added tax, and, 9.38 Seed Enterprise Investment Scheme disposal relief, 12.12 income tax relief, 12.11 introduction, 12.10 reinvestment relief, 12.13 share-for-share exchanges 25% test, 8.8 anti-avoidance, 8.17–8.18 application of provisions, 8.11–8.14 Case 1 test, 8.8 Case 2 test, 8.9 Case 3 test, 8.10 conclusion, 8.21 degrouping charge, and, 8.20 examples, 8.19 introduction, 8.1 legislative background, 8.2–8.18 meaning of ‘share’, 8.15–8.16 NAP Holdings case, 8.14 ownership of voting power, 8.10 relevant circumstances, 8.6–8.10 requirements, 8.2–8.5 ‘share’, 8.15–8.16 stamp taxes, 8.22 takeovers of public companies, 8.9 value added tax, 8.23–8.30 Woolcombers case, 8.13

679

Index Deemed reorganisations – contd substantial shareholding exemption, and conclusion, 11.9 disposals, 11.4–11.5 flow chart, 11.10 internal reorganisations, 11.2–11.3 introduction, 11.1 QCB conversion, 11.6–11.7 share-for share exchanges, 11.2–11.5 simple reorganisations, 11.8 Venture Capital Trusts disposal relief, 12.18 distribution relief, 12.17 exchange of shares owned by individual, 12.16–12.18 exchange of shares owned by Trust, 12.15 ‘front end’ income tax relief, 12.16 introduction, 12.14 Deferral relief Enterprise Investment Scheme, and, 12.5–12.9 Seed Enterprise Investment Scheme, and, 12.12 Deferred consideration earn-outs, and, 10.3 Degrouping charge company reconstruction relief, and, 18.22–18.23 exempt distributions, and, 24.88–24.89 generally, 1.10 share-for-share exchanges, and, 8.20 Demergers characteristics, 21.4 corporation tax, and, 21.2 definition, 21.2 direct demergers conclusion, 22.12 distribution in specie, by, 22.10 generally, 22.8 introduction, 22.5 nature, 22.8 other mechanisms, by, 22.11 schemes of reconstruction, and, 22.8 stamp taxes, 22.13, 24.113 tax consequences, 22.9 value added tax, 24.115–24.118 dissolution without winding up, and, 22.2

Demergers – contd distribution in specie direct demergers, and, 22.10 exempt distributions, 24.1 introduction, 22.1 liquidation distributions, 23.1 ‘return of capital’ demergers, 25.2 EU cross-border demergers see also EU cross-border demergers conclusion, 26.59 further reliefs, 26.52–26.56 interaction with overseas equivalents to Directive provisions, 26.57 introduction, 26.1 legal background, 26.2–26.6 specific legislation, 26.27–26.51 stamp taxes, 26.60 transactions, 26.8–26.26 UK equivalents to Directive divisions, 26.58 value added tax, 26.61–26.64 EU legislation, and, 22.3 exempt distributions see also Exempt distributions activity requirements, 24.27–24.28 additional provisions, 24.83–24.91 advance clearances, 24.64–24.73 anti-avoidance, 24.31–24.36 benefits test, 24.29–24.30 chargeable payments, 24.50–24.63 commercial issues, 24.111 conclusion, 24.112 direct demergers, and, 24.37–24.38 effect of provisions, 24.10–24.11 examples, 24.92–24.110 HMRC powers of information, 24.79–24.81 indirect demergers, and, 24.39–24.49 interpretation provisions, 24.82 introduction, 24.1 introductory provisions, 24.8–24.9 legal background, 24.2–24.5 pre-transaction clearances, 24.64–24.73 residence requirement, 24.25–24.26 returns, 24.74–24.78 stamp taxes, 24.113–24.114 subsidiary demergers, 24.47–24.48

680

Index Demergers – contd exempt distributions – contd tax analysis, 24.6–24.82 value added tax, 24.115–24.127 indirect demergers conclusion, 22.16 generally, 22.14 introduction, 22.6 schemes of reconstruction, and, 22.14 stamp taxes, 22.17, 24.114 tax consequences, 22.15 value added tax, 24.119–24.127 introduction, 21.1 legal background direct demergers, 22.8–22.13 indirect demergers, 22.14–22.17 introduction, 22.1 structures, 22.4–22.7 legal basis, 22.1 liquidation distributions see also Liquidation distributions capital allowance balancing charges, 23.16 commercial analysis, 23.18–23.20 conclusion, 23.21 conditions, 23.5–23.9 dissenting shareholders, 23.19 group hold-over relief unwinds, 23.17 introduction, 23.1 legal background, 23.2–23.3 liquidator indemnities, 23.20 new holding company, and, 23.18 overview, 22.1 purpose, 23.1 reliefs, 23.10–23.14 stamp taxes, 23.22 tax analysis, 23.4–23.17 TCGA, s 179 charges, 23.15 value added tax, 23.23–23.27 meaning, 21.2 purpose, 21.3 reduction of capital, 22.1 ‘return of capital’ demergers see also ‘Return of capital’ demergers additional provisions, 25.23–25.24 conclusion, 25.25 distributions legislation, 25.7 legal background, 25.3–25.12

Demergers – contd ‘return of capital’ demergers – contd legal process, 25.10 meaning, 25.1 new top company, 25.8 purpose, 25.2 reconstruction, as, 25.14–25.18 reduction of capital, 25.4–25.6 reliefs for corporate shareholders, 25.21 reliefs for distributing company, 25.19 reliefs for non-corporate shareholders, 25.20 segregational demergers, 25.22 stamp duty, 25.26 stamp duty land tax, 25.27–25.28 tax analysis, 25.13–25.22 timetable, 25.11 valuation, 25.9 value added tax, 25.29–25.30 schemes of reconstruction, and, 22.8 stamp taxes direct demergers, 22.13, 24.113 indirect demergers, 22.17. 24.114 structures choice, 22.7 direct demergers, 22.5 indirect demergers, 22.6 introduction, 22.4 three-cornered demergers, 22.6 value added tax direct demergers, 24.115–24.118 indirect demergers, 24.119–24.127 value added tax (direct demergers) distributing company’s position, 24.117 introduction, 24.115 subsidiary’s position, 24.118 ultimate shareholders’ position, 24.116 value added tax (indirect demergers of trade) distributing company’s position, 24.121 introduction, 24.119 New Co’s position, 24.122 ultimate shareholders’ position, 24.120

681

Index Demergers – contd value added tax (indirect demergers of subsidiary) distributing company’s position, 24.125 introduction, 24.123 New Co’s position, 24.126 subsidiary’s position, 24.127 ultimate shareholders’ position, 24.124 winding up, and, 22.2 Derivative contracts cross-border mergers, and generally, 28.28 mergers leaving assets within UK tax charge, 20.36 EU branch incorporations, and, 28.28 EU cross-border demergers, and, 26.55 Direct demergers see also Demergers conclusion, 22.12 distribution in specie, by, 22.10 exempt distributions examples, 24.93–24.96 generally, 24.37–24.38 introduction, 24.15 relief for corporate shareholders, 24.96 relief for distributing company, 24.94 relief for non-corporate shareholders, 24.95 TCGA, s 192 provisions, and, 24.86–24.87 transfer of shares in subsidiaries, 24.15 generally, 22.8 introduction, 22.5 liquidation, and, 22.11 nature, 22.8 other mechanisms, by, 22.11 return of capital, and, 22.11 schemes of reconstruction, and, 22.8 stamp taxes, 22.13, 24.113 tax consequences, 22.9 value added tax, 24.115–24.118 Disclosure of tax avoidance schemes stamp duty land tax, and, 2.22 Disposal of assets transfer of assets to non-resident company, and, 27.14–27.15

Disposal of securities transfer of assets to non-resident company, and, 27.12–27.13 Disposal relief Enterprise Investment Scheme, and, 12.4 Venture Capital Trusts, and, 12.18 Dissenting shareholders liquidation distribution, and, 23.19 Dissolution mergers, and, 19.4 Distribution relief Venture Capital Trusts, and, 12.17 Distributions cross-border mergers, and, 20.61–20.63 mergers, and capital gains tax con sequences, 19.24 corporate shareholders, and, 19.22 generally, 19.21 non-corporate shareholders, and, 19.23 reduction of share capital, and, 6.29 return of capital’ demergers, and, 25.7 Distributions in specie see also Demergers direct demergers, and, 22.10 EU cross-border demergers, and introduction, 26.11 transfer by distributing company of subsidiary, 26.19–26.122 transfer by distributing company of trade, 26.15–26.18 transfer of shares in subsidiaries to members, 26.12–26.14 exempt distributions, 24.1 introduction, 22.1 liquidation distributions, 23.1 ‘return of capital’ demergers, 25.2 Divisions ‘but for the Mergers Directive’, 26.44 company law, 26.2 conclusions, 26.59 CTA 2010, s 1078, 26.28–26.29 derivative contracts, 26.55 distributions in specie, by introduction, 26.11 transfer by distributing company of subsidiary, 26.19–26.122

682

Index Divisions – contd distributions in specie, by – contd transfer by distributing company of trade, 26.15–26.18 transfer of shares in subsidiaries to members, 26.12–26.14 division of business in cross-border transfer, 26.28–26.29 EU Mergers Directive, and, 4.20 further reliefs derivative contracts, 26.55 intangible fixed assets, 26.53 introduction, 26.52 loan relationships, 26.54 TCGA, s 140A, and, 26.53–26.55 TCGA, s 140C, and, 26.56 generally, 4.20 intangible fixed assets, 26.53 interaction with overseas equivalents to Directive provisions, 26.57 introduction, 26.1 legal background Mergers Directive, 26.4–26.6 UK company law, 26.2 UK tax law, 26.3 legislation arising from Directive, 26.59 liquidation demergers introduction, 26.8 Mergers Directive, and, 26.10 TFEU, and, 26.9 loan relationships, 26.54 meaning, 26.5 Mergers Directive divisions, 26.5 introduction, 26.4 partial divisions, 26.6 specific legislation, 26.27–26.51 non-UK trade (TCGA, ss 140C–140D) anti-avoidance, 26.47–26.48 ‘but for the Mergers Directive’, 26.44 extent to which local relief can be taken into account in computing tax charge, 26.45 introduction, 26.27 mechanism of relief, 26.42–26.43 partial divisions, 26.40–26.41 qualifying conditions, 26.39 restriction on double relief, 26.46

Divisions – contd reduction of capital, by introduction, 26.23 Mergers Directive, and, 26.25 TFEU, and, 26.24 securities issued on division of business, 26.49–26.51 specific legislation CTA 2010, s 1078, 26.28–26.29 introduction, 26.27 TCGA, ss 140A–140B, 26.30–26.38 TCGA, ss 140C–140D, 26.39–26.48 TCGA, s 140DA, 26.49–26.51 stamp taxes, 26.60 tax law, 26.3 TCGA, ss 140A–140B anti-avoidance, 26.37–26.38 ‘appropriate conditions’ for transferee, 26.33–26.34 introduction, 26.27 mechanism of relief, 26.35–26.36 partial divisions, 26.31–26.32 pre-transaction clearances, 26.38 qualifying conditions, 26.30 TCGA, ss 140C–140D anti-avoidance, 26.47–26.48 ‘but for the Mergers Directive’, 26.44 extent to which local relief can be taken into account in computing tax charge, 26.45 introduction, 26.27 mechanism of relief, 26.42–26.43 partial divisions, 26.40–26.41 qualifying conditions, 26.39 restriction on double relief, 26.46 TCGA, s 140DA, 26.49–26.51 transactions conclusions, 26.26 distributions in specie, 26.11–26.22 introduction, 26.7 liquidation demergers, 26.8–26.10 reduction of capital demergers, 26.23–26.25 transfer by distributing company of subsidiary and issue of shares by transferee introduction, 26.19–26.20 Mergers Directive, and, 26.22 TFEU, and, 26.21

683

Index Divisions – contd transfer by distributing company of trade and issue of shares by transferee introduction, 26.15–26.16 Mergers Directive, and, 26.18 TFEU, and, 26.17 transfer of shares in subsidiaries to members introduction, 26.12 Mergers Directive, and, 26.14 TFEU, and, 26.13 UK business (TCGA, ss 140A–140B) anti-avoidance, 26.37–26.38 ‘appropriate conditions’ for transferee, 26.33–26.34 introduction, 26.27 mechanism of relief, 26.35–26.36 partial divisions, 26.31–26.32 pre-transaction clearances, 26.38 qualifying conditions, 26.30 UK company law generally, 26.2 introduction, 4.13 UK equivalents to Directive divisions, 26.58 UK tax law, 26.3 value added tax introduction, 26.61 transferor company not UK resident, transferee company UK resident, 26.63 transferor company UK resident, transferee company not, 26.62 Double relief transfer of assets to non-resident company, and, 27.20–27.21 Dual resident investment companies intangible fixed assets relief, and, 18.40 Earn-outs avoidance condition election out, 10.6–10.7 generally, 10.4–10.5 conclusion, 10.20 consequences of treatment, 10.8–10.9 deferred consideration, 10.3

Earn-outs – contd election out avoidance condition, 10.6–10.7 generally, 10.14–10.15 replacement of right, 10.12–10.13 employment-related securities legislation, and, 10.19 examples, 10.18 introduction, 10.1 legislative background avoidance condition, 10.4–10.7 consequences of treatment, 10.8–10.9 meaning of ‘earn-out’, 10.2–10.3 replacement of right, 10.10–10.13 meaning, 10.2–10.3 replacement of right election out, 10.12–10.13 generally, 10.10–10.11 stamp taxes, 10.21 ‘unascertainable’, 10.16–10.17 value added tax, and, 10.22 Election earn-outs, and avoidance condition, 10.6–10.7 generally, 10.14–10.15 replacement of right, 10.12–10.13 Employment-related securities legislation earn-outs, and, 10.19 Enterprise Investment Scheme capital gains tax deferral relief, 12.5–12.9 disposal relief, 12.4 income tax relief, 12.3 introduction, 12.2 Equal entitlement to new shares reconstructions, and, 16.7–16.8 Equation of original shares reorganisation of share capital, and, 6.18–6.19 EU branch incorporations see also Branch incorporations anti-avoidance TCGA, ss 140A–140B, 28.12–28.13 TCGA, ss 140C–140D, 28.21–28.22 ‘appropriate conditions’ for transferee, 28.7–28.8 conclusions, 28.30 derivative contracts, 28.28

684

Index EU branch incorporations – contd further reliefs derivative contracts, 28.28 intangible fixed assets, 28.26 introduction, 28.25 loan relationships, 28.27 TCGA, s 140A, and, 28.26–28.28 TCGA, s 140C, and, 28.29 intangible fixed assets, 28.26 introduction, 28.1 loan relationships, 28.27 mechanism of relief TCGA, ss 140A–140B, 28.9–28.10 TCGA, ss 140C–140D, 28.17–28.18 partial divisions, and, 28.6 pre-transaction clearances, 28.13 qualifying conditions TCGA, ss 140A–140B, 28.4–28.5 TCGA, ss 140C–140D, 28.14–28.15 restriction on double relief, 28.19–28.20 securities issued on division of business, 28.24 stamp taxes, 28.31 subsequent disposals of assets or shares or debentures TCGA, ss 140A–140B, 28.11 TCGA, ss 140C–140D, 28.16 TCGA, ss 140A–140B, and anti-avoidance, 28.12–28.13 ‘appropriate conditions’ for transferee, 28.7–28.8 introduction, 28.3 mechanism of relief, 28.9–28.10 partial divisions, and, 28.6 pre-transaction clearances, 28.13 qualifying conditions, 28.4–28.5 subsequent disposals of assets or shares or debentures, 28.11 TCGA, ss 140C–140D, and anti-avoidance, 28.21–28.22 comparison with TCGA, s 140, 28.23 introduction, 28.3 mechanism of relief, 28.17–28.18 qualifying conditions, 28.14–28.15 restriction on double relief, 28.19–28.20 securities issued on division of business, and, 28.24 subsequent disposals of assets or shares or debentures, 28.16

EU branch incorporations – contd transfers of assets, 28.2 value added tax, 28.32–28.33 EU cross-border demergers see also Cross-border mergers ‘but for the Mergers Directive’, 26.44 company law, 26.2 conclusions, 26.59 CTA 2010, s 1078, 26.28–26.29 derivative contracts, 26.55 distributions in specie, by introduction, 26.11 transfer by distributing company of subsidiary, 26.19–26.122 transfer by distributing company of trade, 26.15–26.18 transfer of shares in subsidiaries to members, 26.12–26.14 division of business in cross-border transfer, 26.28–26.29 further reliefs derivative contracts, 26.55 intangible fixed assets, 26.53 introduction, 26.52 loan relationships, 26.54 TCGA, s 140A, and, 26.53–26.55 TCGA, s 140C, and, 26.56 intangible fixed assets, 26.53 interaction with overseas equivalents to Directive provisions, 26.57 introduction, 26.1 legal background Mergers Directive, 26.4–26.6 UK company law, 26.2 UK tax law, 26.3 legislation arising from Directive, 26.59 liquidation demergers introduction, 26.8 Mergers Directive, and, 26.10 TFEU, and, 26.9 loan relationships, 26.54 Mergers Directive divisions, 26.5 introduction, 26.4 partial divisions, 26.6 specific legislation, 26.27–26.51 reduction of capital, by introduction, 26.23 Mergers Directive, and, 26.25 TFEU, and, 26.24

685

Index EU cross-border demergers – contd securities issued on division of business, 26.49–26.51 specific legislation CTA 2010, s 1078, 26.28–26.29 introduction, 26.27 TCGA, ss 140A–140B, 26.30–26.38 TCGA, ss 140C–140D, 26.39–26.48 TCGA, s 140DA, 26.49–26.51 stamp taxes, 26.60 tax law, 26.3 TCGA, ss 140A–140B, anti-avoidance, 26.37–26.38 ‘appropriate conditions’ for transferee, 26.33–26.34 introduction, 26.27 mechanism of relief, 26.35–26.36 partial divisions, 26.31–26.32 pre-transaction clearances, 26.38 qualifying conditions, 26.30 TCGA, ss 140C–140D, anti-avoidance, 26.47–26.48 ‘but for the Mergers Directive’, 26.44 extent to which local relief can be taken into account in computing tax charge, 26.45 introduction, 26.27 mechanism of relief, 26.42–26.43 partial divisions, 26.40–26.41 qualifying conditions, 26.39 restriction on double relief, 26.46 TCGA, s 140DA, 26.49–26.51 transactions conclusions, 26.26 distributions in specie, 26.11–26.22 introduction, 26.7 liquidation demergers, 26.8–26.10 reduction of capital demergers, 26.23–26.25 transfer by distributing company of subsidiary and issue of shares by transferee introduction, 26.19–26.20 Mergers Directive, and, 26.22 TFEU, and, 26.21

EU cross-border demergers – contd transfer by distributing company of trade and issue of shares by transferee introduction, 26.15–26.16 Mergers Directive, and, 26.18 TFEU, and, 26.17 transfer of shares in subsidiaries to members introduction, 26.12 Mergers Directive, and, 26.14 TFEU, and, 26.13 UK company law, 26.2 UK equivalents to Directive divisions, 26.58 UK tax law, 26.3 value added tax introduction, 26.61 transferor company not UK resident, transferee company UK resident, 26.63 transferor company UK resident, transferee company not, 26.62 EU legislation Cross-Border Conversion Directive 2019/2121, 4.15 Cross-Border Mergers Directive 2005/56/EC introduction, 4.25 Sevic case, 4.26 UK implementation, 4.27 divisions ‘divisions’, 4.20 generally, 4.12 UK company law, 4.13 domestic legislation, and, 4.3 European Company Statute commercial considerations, 4.35 comparison with UK public companies, 4.33 compliance, 4.37 conclusion, 4.40 continuity for transitional purposes, 4.37 cross-border conversions, 4.38 European cooperatives, 4.29 formation of SE, 4.34 future developments, 4.39 introduction, 4.28 purpose, 4.32

686

Index EU cross-border demergers – contd European Company Statute – contd relevance to UK legislation on mergers, 4.30 residence of SE, 4.36 Societas Europaea, 4.31 UK public companies, and, 4.33 hierarchy, 4.4 introduction, 4.2–4.5 mergers divisions, 4.20 EU Directive, 4.16–4.24 exchanges of shares, 4.22 generally, 4.7 ‘merger’, 4.19 partial divisions, 4.20 summary, 4.23 transfers of assets, 4.21 UK company law, 4.8 Mergers Directive see also EU Mergers Directive introduction, 4.16 purpose, 4.17 relevant transactions, 4.18–4.22 summary, 4.23 UK implementation, 4.24 overview, 4.1 ‘partial divisions’, 4.20 purposive nature, 4.2 relationship with domestic legislation, 4.3 Sixth Company Law Directive 82/891/EC divisions, 4.12–4.13 introduction, 4.10 purpose, 4.11 UK implementation, 4.14 Third Company Law Directive 78/855/EC introduction, 4.5 mergers, 4.7–4.8 purpose, 4.6 UK implementation, 4.9 EU Mergers Directive division see also EU cross-border demergers generally, 26.5 introduction, 4.20

EU Mergers Directive – contd division of non-UK trade (TCGA, ss 140C–140D) anti-avoidance, 26.47–26.48 ‘but for the Mergers Directive’, 26.44 extent to which local relief can be taken into account in computing tax charge, 26.45 introduction, 26.27 mechanism of relief, 26.42–26.43 partial divisions, 26.40–26.41 qualifying conditions, 26.39 restriction on double relief, 26.46 division of UK business (TCGA, ss 140A–140B) anti-avoidance, 26.37–26.38 ‘appropriate conditions’ for transferee, 26.33–26.34 introduction, 26.27 mechanism of relief, 26.35–26.36 partial divisions, 26.31–26.32 pre-transaction clearances, 26.38 qualifying conditions, 26.30 effect, 27.59 exchanges of shares, 4.22 implementation in UK generally, 28.3 introduction, 28.1 TCGA, ss 140A–140B, 28.4–28.13 TCGA, ss 140C–140D, 28.14–28.22 introduction, 4.16 ‘merger’, 4.19 partial division see also EU cross-border demergers generally, 26.6 introduction, 4.20 purpose, 4.17 relevant transactions divisions, 4.20 exchanges of shares, 4.22 generally, 4.18 ‘merger’, 4.19 partial divisions, 4.20 transfers of assets, 4.21 summary, 4.23 transfer of assets see also EU branch incorporations generally, 28.2 introduction, 4.21

687

Index EU Mergers Directive – contd transfer of non-UK trade (TCGA, ss 140C–140D) anti-avoidance, 28.21–28.22 comparison with TCGA, s 140, 28.23 introduction, 28.3 mechanism of relief, 28.17–28.18 qualifying conditions, 28.14–28.15 restriction on double relief, 28.19–28.20 securities issued on division of business, and, 28.24 subsequent disposals of assets or shares or debentures, 28.16 transfer of UK trade (TCGA, ss 140A–140B) anti-avoidance, 28.12–28.13 ‘appropriate conditions’ for transferee, 28.7–28.8 introduction, 28.3 mechanism of relief, 28.9–28.10 partial divisions, and, 28.6 pre-transaction clearances, 28.13 qualifying conditions, 28.4–28.5 securities issued on division of business, and, 28.24 subsequent disposals of assets or shares or debentures, 28.11 UK implementation, 4.24 European Company Statute commercial considerations, 4.35 comparison with UK public companies, 4.33 compliance, 4.37 conclusion, 4.40 continuity for transitional purposes, 4.37 cross-border conversions, 4.38 European cooperatives, 4.29 formation of SE, 4.34 future developments, 4.39 introduction, 4.28 purpose, 4.32 relevance to UK legislation on mergers, 4.30 residence of SE, 4.36 Societas Europaea commercial considerations, 4.35 comparison with UK public companies, 4.33

European Company Statute – contd Societas Europaea – contd compliance, 4.37 formation, 4.34 generally, 4.31 purpose, 4.32 residence, 4.36 UK public companies, and, 4.33 European cooperatives generally, 4.29 Exchange of shares 25% test, 8.8 anti-avoidance, 8.17–8.18 application of provisions, 8.11–8.14 basic requirements, 8.2–8.5 Case 1 test, 8.8 Case 2 test, 8.9 Case 3 test, 8.10 conclusion, 8.21 debentures, and, 8.1 degrouping charge, and, 8.20 EU Mergers Directive, and, 4.22 examples, 8.19 introduction, 8.1 legislative background anti-avoidance, 8.17–8.18 application of provisions, 8.11–8.14 meaning of ‘share’, 8.15–8.16 relevant circumstances, 8.6–8.10 requirements, 8.2–8.5 meaning of ‘share’, 8.15–8.16 NAP Holdings case, 8.14 ‘ordinary share capital’, 8.15–8.16 ownership of voting power, 8.10 relevant circumstances Case 1 test, 8.8 Case 2 test, 8.9 Case 3 test, 8.10 general, 8.6–8.7 requirements, 8.2–8.5 ‘share’, 8.15–8.16 stamp taxes, 8.22 takeovers of public companies, 8.9 value added tax buyer’s position, 8.26–8.30 expenses incurred in another company, 8.28 hive-up, 8.30 introduction, 8.23 nominee belonging outside the EU, 8.25

688

Index Exchange of shares – contd value added tax – contd registration, 8.27 seller’s position, 8.24–8.25 Target company position, 8.29 Venture Capital Trusts, and shares owned by individual, 12.16–12.18 shares owned by Trust, 12.15 Woolcombers case, 8.13 Exempt distributions see also Demergers activity requirements, 24.27–24.28 additional provisions, 24.83–24.91 advance clearances conditions attached, 24.73 decision of Commissioners or tribunal, 24.70–24.71 distributions, of, 24.65 introduction, 24.64 payments, of, 24.66–24.67 practical issues, 24.72 requirements as to applications, 24.68–24.69 anti-avoidance cessation or sale of trade, 24.36 change of control, 24.35 generally, 24.31–24.32 making chargeable payments, 24.34 tax-avoidance motive, 24.33 balancing charges, 24.109 basic provision, 24.10–24.11 benefits test, 24.29–24.30 capital allowances, 24.109 change of control, and, 24.35 chargeable payments anti-avoidance, and, 24.34 basic charge, 24.51–24.52 ‘company concerned in an exempt distribution’, 24.61–24.62 ‘connected’, 24.62 definition, 24.55–24.56 generally, 24.50 not deductible in calculating profits, 24.53–24.54 practical advice, 24.63 unquoted companies, and, 24.57–24.60

Exempt distributions – contd clearances conditions attached, 24.73 decision of Commissioners or tribunal, 24.70–24.71 distributions, of, 24.65 introduction, 24.64 payments, of, 24.66–24.67 practical issues, 24.72 requirements as to applications, 24.68–24.69 commercial issues, 24.111 conclusion, 24.112 definitions, 24.8–24.9 degrouping charge, and, 24.88–24.89 direct demergers examples, 24.93–24.96 generally, 24.37–24.38 introduction, 24.15 relief for corporate shareholders, 24.96 relief for distributing company, 24.94 relief for non-corporate shareholders, 24.95 TCGA, s 192 provisions, and, 24.86–24.87 transfer of shares in subsidiaries, 24.15 distributable reserves, 24.111 ‘distributing company’, 24.20–24.21 division of business in cross-border transfer, 24.19 effect of provisions, 24.10–24.11 examples direct demergers, 24.93–24.96 indirect demergers – subsidiaries, 24.106 indirect demergers – trade, 24.97–24.105 introduction, 24.92 general conditions activity requirements, 24.27–24.28 anti-avoidance, 24.31–24.36 benefits test, 24.29–24.30 introduction, 24.24 residence requirement, 24.25–24.26 group hold-over relief, 24.110 HMRC powers of information, 24.79–24.81

689

Index Exempt distributions – contd indirect demergers activities of transferee company, 24.44 distributing company, 24.46 distributing company as a 75 per cent subsidiary, 24.47–24.48 examples, 24.97–24.107 generally, 24.39–24.41 introduction, 24.17 minor interest provision, 24.42 reconstructions, and, 24.98–24.102 relief for corporate shareholders, 24.105 relief for distributing company, 24.103 relief for non-corporate shareholders, 24.104 shares issued by transferee company, 24.45 subsidiaries, 24.106 trade, 24.97–24.105 transfer by distributing company and issue of shares by transferee company, 24.17 transferred shares, 24.43 interpretation provisions, 24.82 introduction, 24.1 introductory provisions, 24.8–24.9 key terms, 24.8–24.9 legal background activity requirements, 24.27–24.28 anti-avoidance, 24.31–24.36 benefits test, 24.29–24.30 conclusions, 24.49 direct demergers, and, 24.37–24.38 effect of provisions, 24.10–24.11 indirect demergers, and, 24.39–24.49 introduction, 24.2–24.5 introductory provisions, 24.8–24.9 meaning, 24.12–24.23 overview, 24.6 residence requirement, 24.25–24.26 structure, 24.7 subsidiary demergers, 24.47–24.48 meaning, 24.10–24.11 pre-transaction clearances conditions attached, 24.73 decision of Commissioners or tribunal, 24.70–24.71

Exempt distributions – contd pre-transaction clearances – contd distributions, of, 24.65 introduction, 24.64 payments, of, 24.66–24.67 practical issues, 24.72 requirements as to applications, 24.68–24.69 principles, 24.4–24.5 purpose, 24.1 ‘relevant company’, 24.22–24.23 residence requirement, 24.25–24.26 returns, 24.74–24.78 stamp taxes direct demergers, 22.13, 24.113 indirect demergers, 22.17, 24.114 subsidiary demergers, 24.47–24.48 tax analysis, 24.6–24.82 TCGA, s 179 charges, 24.108 TCGA, s 192 provisions, 24.83–24.91 terms, 24.8–24.9 transfer by distributing company and issue of shares by transferee company, 24.16–24.18 transfer of shares in subsidiaries, 24.14–24.15 value added tax direct demergers, 24.115–24.118 indirect demergers, 24.119–24.127 value added tax (direct demergers) distributing company’s position, 24.117 introduction, 24.115 subsidiary’s position, 24.118 ultimate shareholders’ position, 24.116 value added tax (indirect demergers of trade) distributing company’s position, 24.121 introduction, 24.119 New Co’s position, 24.122 ultimate shareholders’ position, 24.120 value added tax (indirect demergers of subsidiary) distributing company’s position, 24.125 introduction, 24.123

690

Index Exempt distributions – contd value added tax (indirect demergers of subsidiary) – contd New Co’s position, 24.126 subsidiary’s position, 24.127 ultimate shareholders’ position, 24.124 Follower notices generally, 1.65 Foreign permanent establishment branch incorporations, and, 27.2 Friendly societies intangible fixed assets relief, and, 18.40 General anti-abuse rule (GAAR) Advisory Panel, 1.62 background, 1.60 general, 1.61 guidance, 1.63 Group companies liquidation distribution, and, 23.17 reconstructions, and generally, 16.16–16.17 intangible fixed assets relief, 18.38 substantial shareholding exemption, and, 1.15 Group hold-over relief unwinds liquidation distribution, and, 23.17 Group relationship rules Gallaher decision, 1.9 generally, 1.8 Group transfer relief stamp duty land tax, and, 2.18 stamp duty (reserve tax), and, 2.9 Hold-over relief unwinds liquidation distribution, and, 23.17 Income tax Enterprise Investment Scheme, and, 12.3 Seed Enterprise Investment Scheme, and, 12.11 Venture Capital Trusts, and, 12.16 Increase in share capital bonus issues, 6.9 combined issues, 6.14 introduction, 6.8 open offers, 6.12

Increase in share capital – contd rights issues, 6.10–6.11 summary, 6.15 vendor placements, 6.13 Indexation allowance reorganisation of share capital, and, 6.26–6.27 Indirect demergers see also Demergers conclusion, 22.16 exempt distributions activities of transferee company, 24.44 distributing company, 24.46 distributing company as a 75 per cent subsidiary, 24.47–24.48 examples, 24.97–24.107 generally, 24.39–24.41 introduction, 24.17 minor interest provision, 24.42 reconstructions, and, 24.98 relief for corporate shareholders, 24.105 relief for distributing company, 24.103 relief for non-corporate shareholders, 24.104 shares issued by transferee company, 24.45 subsidiaries, 24.106 trade, 24.97–24.105 transfer by distributing company and issue of shares by transferee company, 24.17 transferred shares, 24.43 generally, 22.14 introduction, 22.6 schemes of reconstruction, and, 22.14 stamp taxes, 22.17, 24.114 subsidiaries, 24.106 tax consequences, 22.15 trade introduction, 24.97 reconstructions, and, 24.98–24.102 relief for corporate shareholders, 24.105 relief for distributing company, 24.103

691

Index Indirect demergers – contd trade – contd relief for non-corporate shareholders, 24.104 subsidiaries, 24.106 value added tax, 24.119–24.127 Intangible fixed assets see also Intangible fixed assets relief branch incorporations, and, 27.28–27.29 EU cross-border demergers, and, 26.53 Intangible fixed assets relief (CTA 2009, Part 8) basic relief, 18.33–18.34 branch incorporations, and, 27.28–27.29 chargeable gains, and, 18.43 clearances, 18.41–18.42 conclusion, 18.44 cross-border mergers, and mergers leaving assets outside UK tax charge, 20.46 mergers leaving assets within UK tax charge, 20.34 dual resident investment companies, 18.40 exclusions, 18.39–18.40 friendly societies, 18.40 group transfers, and, 18.38 interaction with other provisions, 18.37–18.38 introduction, 18.32 motive test, 18.41–18.42 related party transactions, and, 18.43 scope, 18.35–18.36 stamp duty, 18.45 unit trusts, 18.40 value added tax, 18.46 Intra-group transactions transfer of assets to non-resident company, and, 27.17 Investment schemes conclusion, 12.21 Corporate Venturing Scheme, 12.19 Enterprise Investment Scheme capital gains tax relief, 12.4–12.5 deferral relief, 12.5–12.9 disposal relief, 12.4 income tax relief, 12.3 introduction, 12.2

Investment schemes – contd introduction, 12.1 investors’ relief, 12.20 Seed Enterprise Investment Scheme disposal relief, 12.12 income tax relief, 12.11 introduction, 12.10 reinvestment relief, 12.13 Venture Capital Trusts disposal relief, 12.18 distribution relief, 12.17 exchange of shares owned by individual, 12.16–12.18 exchange of shares owned by Trust, 12.15 ‘front end’ income tax relief, 12.16 introduction, 12.14 Investors’ relief generally, 12.20 Issue of ordinary share capital generally, 16.5–16.6 ‘ordinary share capital’, 16.26 Land and buildings transaction tax (LBTT) additional dwellings supplement, 2.24 anti-avoidance, 2.25 general application, 2.23 scope, 2.23 Land transaction tax (LTT) anti-avoidance, 2.30 application, 2.26 higher residential rates, 2.28 non-residential property rates, 2.29 rates, 2.27–2.29 scope, 2.26 Liquidation direct demergers, and, 22.11 Liquidation distributions see also Demergers capital allowance balancing charges, 23.16 commercial issues dissenting shareholders, 23.19 liquidator indemnities, 23.20 new holding company, 23.18 conclusion, 23.21 conditions, 23.5–23.9 dissenting shareholders, 23.19

692

Index Liquidation distributions – contd EU cross-border demergers, and introduction, 26.8 Mergers Directive, and, 26.10 TFEU, and, 26.9 group hold-over relief unwinds, 23.17 introduction, 23.1 legal background, 23.2–23.3 liquidator indemnities, 23.20 new holding company, and, 23.18 overview, 22.1 purpose, 23.1 reliefs corporate shareholders, for, 23.14 distributing company, for, 23.10 non-corporate shareholders, for, 23.13 stamp taxes, 23.22 tax analysis further issues, 23.15–23.17 introduction, 23.4 reconstruction, 23.5–23.9 reliefs, 23.10–23.14 TCGA, s 179 charges, 23.15 value added tax distributing company’s position, 23.26 introduction, 23.23 New Cos’ position, 23.27 superimposition of New Top Co, 23.24 ultimate shareholders’ position, 23.25 Loan relationships conversion into qualifying corporate bonds, and generally, 9.21–9.22 priority, 9.33–9.34 cross-border mergers, and mergers leaving assets within UK tax charge, 20.35 EU branch incorporations, and, 28.27 EU cross-border demergers, and, 26.54 Market value part disposal of new holding, and, 6.23 Mergers acquisition, by, 19.11 amalgamation, 19.3

Mergers – contd business combination of merging companies, 19.3 commercial transactions, 19.12 conclusions, 19.30 consideration, 19.5 court’s powers, 19.9 cross-border mergers See also Cross-border mergers conclusions, 20.65 consequential amendments, 20.64 Directive, 4.25–4.27 distributions, 20.61–20.63 FA 2007, s 110, 20.4–20.12 introduction, 20.1 legal background, 20.3 ‘merger’, 20.2 mergers leaving assets outside UK tax charge, 20.37–20.46 mergers leaving assets within UK tax charge, 20.14–20.36 shareholder reliefs, 20.47–20.60 stamp taxes, 20.66 UK Regulations, 20.12 value added tax, 20.67 definition amalgamation, 19.3 business combination of merging companies, 19.3 consideration, 19.5 dissolution, 19.4 EU Directive, 4.19 generally, 19.2 dissolution, 19.4 distributions, as capital gains tax con sequences, 19.24 corporate shareholders, and, 19.22 generally, 19.21 non-corporate shareholders, and, 19.23 divisions, 4.20 downstream, 19.11 effect under CA 2006, s 900, 19.6 EU Directive See also EU Mergers Directive introduction, 4.16 purpose, 4.17 relevant transactions, 4.18–4.22 summary, 4.23 UK implementation, 4.24

693

Index Mergers – contd exchanges of shares, 4.22 formation of new company, by, 19.11 further issues other tax matters, 19.29 TCGA, s 179 exposure, 19.28 generally, 4.7 legal considerations, 19.2–19.10 owner-managed companies, 19.10 partial divisions, 4.20 public companies, 19.8 reconstruction, as conditions, 19.15–19.19 introduction, 19.14 relevant transactions exchanges of shares, 4.22 ‘merger’, 4.19 partial divisions, 4.20 transfers of assets, 4.21 reliefs corporate shareholders, for, 19.26 non-corporate shareholders, for, 19.25 transferor companies, for, 19.20 stamp taxes, 19.31 structures, 19.11 summary, 4.23 tax analysis, 19.13 transfers of assets, 4.21 UK company law, 4.8 up-stream mergers generally, 19.11 special case, 19.27 use of regime court’s powers, 19.9 introduction, 19.7 owner-managed companies, 19.10 public companies, 19.8 value added tax, 19.32 Motive test intangible fixed assets relief, and, 18.41–18.42 New holding company liquidation distribution, and, 23.18 ‘No-disposal’ treatment reconstructions, and, 16.1 Non-statutory tax practices reconstructions, and, 15.6

Open offers increase in share capital, and, 6.12 ‘Ordinary share capital’ reconstructions, and, 16.26 share-for-share exchanges, and, 8.15–8.16 Ownership of voting power share-for-share exchanges, and, 8.10 Part disposal of new holding reorganisation of share capital, and, 6.22–6.23 Partial divisions see also EU cross-border demergers branch incorporations, and, 28.6 generally, 26.6 mergers, and, 4.20 Preliminary reorganisation of share capital generally, 16.22–16.23 shareholder reconstruction relief, 18.7–18.8 Premiums conversion of securities, and, 7.9–7.10 Pre-transaction clearances see also Clearances company reconstruction relief, and, 18.26–18.27 Qualifying corporate bonds, conversion into avoiding currency conversion, 9.5 introduction, 9.3 normal commercial loan, 9.4 conclusion, 9.36 consideration given, 9.19–9.20 consideration received basic approach, 9.17–9.18 more complex approach, 9.29–9.30 QCBs, and, 9.31–9.32 currency conversion, and, 9.5 definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 earn-outs, and, 10.18 examples, 9.35 exemptions, 9.27–9.28 introduction, 9.1

694

Index Qualifying corporate bonds, conversion into – contd legislative background consideration given, 9.19–9.20 consideration received, 9.17–9.18 definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 exemptions, 9.27–9.28 introduction, 9.6 loan relationships, and, 9.21–9.22 new assets, 9.25–9.26 old assets, 9.23–9.24 priority over loan relationship rules, 9.33–9.34 scope of provisions, 9.7–9.10 taxation of consideration received, 9.29–9.32 loan relationships rules, and generally, 9.21–9.22 priority, 9.33–9.34 meaning of ‘qualifying corporate bonds’, 9.2 new assets, 9.25–9.26 normal commercial loan, and, 9.4 old assets, 9.23–9.24 scope of provisions, 9.7–9.10 stamp taxes, and, 9.37 substantial shareholding exemption, and, 11.6–11.7 taxation of consideration received, 9.29–9.32 value added tax, and, 9.38 Reconstruction relief stamp duty land tax, and, 2.18 stamp duty (reserve tax), and anti-avoidance, 2.14 generally, 2.11 insertion of new holding company, 2.12 introduction, 2.10 territorial scope, 2.13 Reconstructions ‘business separations’, 16.14–16.15 chargeable gains, and, 18.43 company reconstruction relief (TCGA, s 139) basic relief, 18.17–18.18 bona fide commercial reason, 18.26–18.27

Reconstructions – contd company reconstruction relief (TCGA, s 139)– contd clearances, 18.26–18.27 collection of unpaid tax, 18.28–18.29 company law issues, 18.15–18.16 conclusion, 18.44 definitions, 18.30–18.31 degrouping charge, 18.22–18.23 exclusions from relief, 18.24–18.25 introduction, 15.4 pre-transaction clearances, 18.26–18.27 purpose, 18.15 scope of relief, 18.20–18.21 stamp duty, 18.45 substantial shareholding exemption, and, 18.19 value added tax, 18.46 compromise or arrangement with members, 16.20–16.21 continuity of business ‘business separations’, 16.14–16.15 group companies, 16.16–16.17 introduction, 16.9 more than one original company, 16.12–16.13 one original company, 16.10–16.11 winding up, etc, and, 16.18–16.19 creditor reconstruction relief (TCGA, s 136) generally, 18.2–18.14 introduction, 15.4 definition background, 15.2–15.9 compromise or arrangement with members, 16.20–16.21 conclusion, 16.28 continuity of business, 16.9–16.19 disregards, 16.22–16.25 equal entitlement to new shares, 16.7–16.8 interpretation provision, 16.26–16.27 introduction, 16.1 introductory paragraph, 16.3–16.4 issue of ordinary share capital, 16.5–16.6 overview, 16.2

695

Index Reconstructions – contd disregards preliminary reorganisation of share capital, 16.22–16.23 subsequent issue of shares, 16.24–16.25 equal entitlement to new shares, 16.7–16.8 group companies, 16.16–16.17 intangible fixed assets relief (CTA 2009, Part 8) basic relief, 18.33–18.34 chargeable gains, and, 18.43 clearances, 18.41–18.42 conclusion, 18.44 dual resident investment companies, 18.40 exclusions, 18.39–18.40 friendly societies, 18.40 group transfers, and, 18.38 interaction with other provisions, 18.37–18.38 introduction, 18.32 motive test, 18.41–18.42 related party transactions, and, 18.43 scope, 18.35–18.36 stamp duty, 18.45 unit trusts, 18.40 value added tax, 18.46 interpretation provision, 16.26–16.27 introduction, 15.1 issue of ordinary share capital generally, 16.5–16.6 ‘ordinary share capital’, 16.26 legislative background early law, 15.4 modern law, 15.7 meaning case law, 15.3 conclusion, 15.9 early legislation, 15.4 generally, 15.5 modern legislation, 15.7 non-statutory tax practices, 15.6 Plain English version, 15.2 mergers, and conditions, 19.15–19.19 introduction, 19.14 more than one original company, 16.12–16.13

Reconstructions – contd nature, 15.5 ‘no-disposal’ treatment, 16.1 non-statutory tax practices, 15.6 one original company, 16.10–16.11 ‘ordinary share capital’, 16.26 preliminary reorganisation of share capital, and, 16.22–16.23 ‘relevant shares’, 16.7 reliefs chargeable gains, and, 18.43 company, 18.15–18.31 conclusion, 18.44 intangible fixed assets, 18.32–18.42 introduction, 18.1 shareholder and creditor, 18.2–18.14 stamp duty, 18.45 value added tax, 18.46 return of capital’ demergers, and, 25.14–25.18 ‘scheme of reconstruction’, 16.3–16.4 share-for-share exchanges, and, 15.4 shareholder reconstruction relief (TCGA, s 136) application of provision, 18.3–18.4 basic exemption, 18.5–18.6 bona fide commercial reason, 18.13 commerciality and fiscal test, 18.13–18.14 companies without share capital, 18.11–18.12 definitions, 18.9–18.10 effect of provision, 18.5–18.6 generally, 18.2 introduction, 15.4 preliminary reorganisations, 18.7–18.8 purpose, 18.2 ‘relevant holdings’, 18.9–18.10 stamp duty, 18.45 value added tax, 18.46 SP 5/85, 15.6 stamp taxes, and, 15.9 subsequent issue of shares, and, 16.24–16.25 transfer of business basic relief, 18.17–18.18 bona fide commercial reason, 18.26–18.27 clearances, 18.26–18.27 collection of unpaid tax, 18.28–18.29

696

Index Reconstructions – contd transfer of business – contd company law issues, 18.15–18.16 conclusion, 18.44 definitions, 18.30–18.31 degrouping charge, 18.22–18.23 exclusions from relief, 18.24–18.25 introduction, 15.4 pre-transaction clearances, 18.26–18.27 purpose, 18.15 scope of relief, 18.20–18.21 stamp duty, 18.45 substantial shareholding exemption, and, 18.19 value added tax, 18.46 value added tax, and, 15.9 winding up, etc, and, 16.18–16.19 Reduction of share capital demergers, and see also ‘Return of capital’ demergers introduction, 22.1 distributions, and, 6.29 EU cross-border demergers, and introduction, 26.23 Mergers Directive, and, 26.25 TFEU, and, 26.24 generally, 6.16–6.17 return of capital’ demergers, and court-approved reduction, 25.5 introduction, 25.4 solvency statement, 25.6 Reinvestment relief Seed Enterprise Investment Scheme, and, 12.13 Related party transactions intangible fixed assets relief, and, 18.43 ‘Relevant holdings’ shareholder reconstruction relief, and, 18.9–18.10 ‘Relevant shares’ reconstructions, and, 16.7 Reliefs chargeable gains, and, 18.43 company reconstruction relief (TCGA, s 139) basic relief, 18.17–18.18 bona fide commercial reason, 18.26–18.27 clearances, 18.26–18.27

Reliefs – contd company reconstruction relief (TCGA, s 139) – contd collection of unpaid tax, 18.28–18.29 company law issues, 18.15–18.16 conclusion, 18.44 definitions, 18.30–18.31 degrouping charge, 18.22–18.23 exclusions from relief, 18.24–18.25 introduction, 15.4 pre-transaction clearances, 18.26–18.27 purpose, 18.15 scope of relief, 18.20–18.21 stamp duty, 18.45 substantial shareholding exemption, and, 18.19 value added tax, 18.46 conclusion, 18.44 intangible fixed assets relief (CTA 2009, Part 8) basic relief, 18.33–18.34 chargeable gains, and, 18.43 clearances, 18.41–18.42 conclusion, 18.44 dual resident investment companies, 18.40 exclusions, 18.39–18.40 friendly societies, 18.40 group transfers, and, 18.38 interaction with other provisions, 18.37–18.38 introduction, 18.32 motive test, 18.41–18.42 related party transactions, and, 18.43 scope, 18.35–18.36 stamp duty, 18.45 unit trusts, 18.40 value added tax, 18.46 introduction, 18.1 liquidation distribution, and corporate shareholders, 23.14 distributing company, 23.10 non-corporate shareholders, 23.13 mergers, and corporate shareholders, for, 19.26 non-corporate shareholders, for, 19.25 transferor companies, for, 19.20

697

Index Reliefs – contd ‘return of capital’ demergers, and corporate shareholders, 25.21 distributing company, 25.19 non-corporate shareholders, 25.20 shareholder reconstruction relief (TCGA, s 136) application of provision, 18.3–18.4 basic exemption, 18.5–18.6 bona fide commercial reason, 18.13 commerciality and fiscal test, 18.13–18.14 companies without share capital, 18.11–18.12 definitions, 18.9–18.10 effect of provision, 18.5–18.6 generally, 18.2 introduction, 15.4 preliminary reorganisations, 18.7–18.8 purpose, 18.2 ‘relevant holdings’, 18.9–18.10 stamp duty, 18.45 value added tax, 18.46 shareholder and creditor, 18.2–18.14 stamp duty land tax, and clawback, 2.21 denial, 2.20 generally, 2.18 stamp duty (reserve tax), and acquisition relief, 2.10–2.14 change in economic ownership, 2.10 generally, 2.8 group transfer relief, 2.9 reconstruction relief, 2.10–2.14 Removing cash-flow benefit accelerated payment notices, 1.66 follower notices, 1.65 generally, 1.64 Reorganisations anti-avoidance bona fide commercial reason test, 13.9 conclusion, 13.23 ‘corporation tax’, 13.18 Craven v White decision, 13.4 Floor v Davis decision, 13.2 Furniss v Dawson decision, 13.3 introduction, 13.1 legislative background, 13.6–13.22

Reorganisations – contd anti-avoidance – contd main purpose, 13.11 motivation, 13.16 persons affected, 13.17 principal test, 13.7–13.18 Snell v HMRC, 13.12–13.15 restricted application of provisions, 13.19–13.20 ‘tax advantage’, 13.10 third party liabilities, 13.21–13.22 case law, 5.4 clearances acknowledgment, 14.15 appeal against Board’s decision, 14.11–14.12 applicants, 14.6 applications, 14.7–14.8, 14.15–14.17 Board’s obligation, 14.9–14.10 conclusion, 14.19 effect, 14.2–14.3 form of application, 14.7–14.8 introduction, 14.1 legislative background, 14.2–14.14 obligation of the Board, 14.9–14.10 practical issues, 14.15–14.17 scope, 14.4 stamp taxes, 14.20 technical conditions, 14.5 timing of applications, 14.16 urgent applications, 14.17 value added tax, 14.21 voiding decisions, 14.13–14.14 conclusion, 5.7 conversion of securities cash payments received, 7.11–7.12 compensation stock, 7.13–7.14 conclusion, 7.15 definition of ‘security’, 7.2 general treatment, 7.3–7.4 introduction, 7.1 legislative background, 7.3–7.14 premiums, 7.9–7.10 conversion of shares into QCBs conclusion, 9.36 consideration given, 9.19–9.20 consideration received, 9.17–9.18 definitions, 9.11–9.14

698

Index Reorganisations – contd conversion of shares into QCBs – contd disapplication of reorganisation provisions, 9.15–9.16 examples, 9.35 exemptions, 9.27–9.28 introduction, 9.1 legislative background, 9.6–9.34 loan relationships, and, 9.21–9.22 meaning of ‘qualifying corporate bonds’, 9.2 new assets, 9.25–9.26 old assets, 9.23–9.24 priority over loan relationship rules, 9.33–9.34 scope of provisions, 9.7–9.10 stamp taxes, and, 9.37 taxation of consideration received, 9.29–9.32 value added tax, and, 9.38 Corporate Venturing Scheme, 12.19 deemed see also Deemed reorganisations anti-avoidance, 13.1–13.23 clearances, 14.1–14.21 earn-outs, 10.1–10.22 introduction, 8.1 investment schemes, and, 12.1–12.21 purpose of legislation, 8.2 QCB exchanges, 9.1–9.38 share-for-share exchanges, 8.1–8.30 substantial shareholding exemption, 11.1–11.10 definition case law, 5.4 dictionary meaning, 5.2 legislation, 5.3 earn-outs avoidance condition, 10.4–10.7 conclusion, 10.20 consequences of treatment, 10.8–10.9 election out, 10.6–10.7, 10.12–10.15 employment-related securities legislation, and, 10.19 introduction, 10.1 legislative background, 10.2–10.17 meaning, 10.2–10.3

Reorganisations – contd earn-outs – contd QCB rules, and, 10.18 replacement of right, 10.10–10.13 stamp taxes, 10.21 ‘unascertainable’, 10.16–10.177 value added tax, and, 10.22 Enterprise Investment Scheme capital gains tax relief, 12.4–12.5 deferral relief, 12.5–12.9 disposal relief, 12.4 income tax relief, 12.3 introduction, 12.2 introduction, 5.1 investment schemes, and conclusion, 12.21 Corporate Venturing Scheme, 12.19 Enterprise Investment Scheme, 12.2–12.9 introduction, 12.1 investors’ relief, 12.20 Seed Enterprise Investment Scheme, 12.10–12.13 Venture Capital Trusts, 12.14–12.18 investors’ relief, 12.20 legislative background achieving intention, 5.6 generally, 5.3 purpose of legislation, 5.5 meaning case law, 5.4 dictionary definition, 5.2 legislation, 5.3 purpose of legislation, 5.5 QCB conversion conclusion, 9.36 consideration given, 9.19–9.20 consideration received, 9.17–9.18 definitions, 9.11–9.14 disapplication of reorganisation provisions, 9.15–9.16 examples, 9.35 exemptions, 9.27–9.28 introduction, 9.1 legislative background, 9.6–9.34 loan relationships, and, 9.21–9.22 meaning of ‘qualifying corporate bonds’, 9.2 new assets, 9.25–9.26 old assets, 9.23–9.24

699

Index Reorganisations – contd QCB conversion – contd priority over loan relationship rules, 9.33–9.34 scope of provisions, 9.7–9.10 stamp taxes, and, 9.37 taxation of consideration received, 9.29–9.32 value added tax, and, 9.38 Seed Enterprise Investment Scheme disposal relief, 12.12 income tax relief, 12.11 introduction, 12.10 reinvestment relief, 12.13 share capital, of see also Share capital reorganisations composite new holdings, 6.24–6.25 conclusion, 6.30 consideration given or received by holder, 6.20–6.21 distributions, and, 6.29 equation of original shares and new holding, 6.18–6.19 examples, 6.28 increases in capital, 6.8–6.15 indexation allowance, 6.26–6.27 introduction, 6.1 legislative background, 6.2–6.27 meaning of ‘reorganisation’, 6.3–6.7 part disposal of new holding, 6.22–6.23 reduction of share capital, 6.16–6.17 share-for-share exchanges 25% test, 8.8 anti-avoidance, 8.17–8.18 application of provisions, 8.11–8.14 Case 1 test, 8.8 Case 2 test, 8.9 Case 3 test, 8.10 conclusion, 8.21 degrouping charge, and, 8.20 examples, 8.19 introduction, 8.1 legislative background, 8.2–8.18 meaning of ‘share’, 8.15–8.16 NAP Holdings case, 8.14 ownership of voting power, 8.10 relevant circumstances, 8.6–8.10 requirements, 8.2–8.5

Reorganisations – contd share-for-share exchanges – contd ‘share’, 8.15–8.16 stamp taxes, 8.22 takeovers of public companies, 8.9 value added tax, 8.23–8.30 Woolcombers case, 8.13 value added tax, and consideration, 3.7 costs from overseas, 3.10 effect of grouping, 3.11 exempt fees, 3.9 fees charged by intermediaries, 3.9 generally, 3.5 input VAT recovery, 3.8 relevant business for VAT, 3.6 transfers of business as a going concern, 3.12–3.14 Venture Capital Trusts disposal relief, 12.18 distribution relief, 12.17 exchange of shares owned by individual, 12.16–12.18 exchange of shares owned by Trust, 12.15 ‘front end’ income tax relief, 12.16 introduction, 12.14 Residence exempt distributions, and, 24.25–24.26 ‘Return of capital’ demergers see also Demergers additional provisions, 25.23–25.24 capital allowances balancing charges, 25.24 Companies Act 2006, and, 25.12 conclusion, 25.25 direct demergers, and, 22.11 distributions legislation, 25.7 legal background Companies Act 2006, and, 25.12 distributions legislation, 25.7 introduction, 25.3 new top company, 25.8 process, 25.10 reduction of capital, 25.4–25.6 timetable, 25.11 valuation, 25.9 legal process, 25.10 meaning, 25.1 new top company, 25.8

700

Index ‘Return of capital’ demergers – contd purpose, 25.2 reconstruction, as, 25.14–25.18 reduction of capital court-approved reduction, 25.5 introduction, 25.4 solvency statement, 25.6 reliefs corporate shareholders, 25.21 distributing company, 25.19 non-corporate shareholders, 25.20 segregational demergers, 25.22 stamp duty, 25.26 stamp duty land tax transfer of Prop Co, 25.28 transfer of property to new holding company, 25.27 tax analysis examples, 25.13–25.22 further issues, 25.23 other issues, 25.24 reconstruction, as, 25.14–25.18 reliefs, 25.19–25.21 segregational demergers, 25.22 TCGA, s 179 charges, 25.23 timetable, 25.11 valuation, 25.9 value added tax preliminary superimposition of Top Co, 25.29 treatment of demerger, 25.30 Reverse charge value added tax, and, 3.10 Rights issues increase in share capital, and, 6.10–6.11 ‘Scheme of reconstruction’ see also Reconstructions meaning, 16.3–16.4 Scrip issues increase in share capital, and, 6.9 Securities, conversion of cash payments received, 7.11–7.12 compensation stock, 7.13–7.14 conclusion, 7.15 definition, 7.5–7.6 definition of ‘security’ generally, 7.5–7.6 introduction, 7.2

Securities, conversion of – contd general treatment, 7.3–7.4 introduction, 7.1 legislative background, 7.3–7.14 premiums, 7.9–7.10 Securities issued on division of business EU cross-border demergers, and, 26.49–26.51 Seed Enterprise Investment Scheme (SEIS) disposal relief, 12.12 income tax relief, 12.11 introduction, 12.10 reinvestment relief, 12.13 Segregational demergers return of capital’ demergers, and, 25.22 Share capital reorganisations composite new holdings, 6.24–6.25 conclusion, 6.30 consideration given or received by holder, 6.20–6.21 distributions, and, 6.29 equation of original shares and new holding, 6.18–6.19 examples, 6.28 increases in capital bonus issues, 6.9 combined issues, 6.14 introduction, 6.8 open offers, 6.12 rights issues, 6.10–6.11 summary, 6.15 vendor placements, 6.13 indexation allowance, 6.26–6.27 introduction, 6.1 legislative background composite new holdings, 6.24–6.25 consideration given or received by holder, 6.20–6.21 equation of original shares and new holding, 6.18–6.19 increases in capital, 6.8–6.15 indexation allowance, 6.26–6.27 introduction, 6.2 meaning of ‘reorganisation’, 6.3–6.7 part disposal of new holding, 6.22–6.23 reduction of share capital, 6.16–6.17

701

Index Share capital reorganisations – contd meaning of ‘reorganisation’ expanded circumstances, 6.5–6.6 generally, 6.3–6.4 Unilever (UK) Holdings Ltd v Smith, 6.7 part disposal of new holding, 6.22–6.23 reduction of share capital distributions, and, 6.29 generally, 6.16–6.17 stamp taxes, and, 6.31 Unilever (UK) Holdings Ltd v Smith, 6.7 value added tax, and company’s position, 6.34 introduction, 6.32 shareholder’s position, 6.33 Share-for-share exchanges 25% test, 8.8 anti-avoidance, 8.17–8.18 application of provisions, 8.11–8.14 basic requirements, 8.2–8.5 Case 1 test, 8.8 Case 2 test, 8.9 Case 3 test, 8.10 conclusion, 8.21 debentures, and, 8.1 degrouping charge, and, 8.20 EU Mergers Directive, and, 4.22 examples, 8.19 introduction, 8.1 legislative background anti-avoidance, 8.17–8.18 application of provisions, 8.11–8.14 meaning of ‘share’, 8.15–8.16 relevant circumstances, 8.6–8.10 requirements, 8.2–8.5 meaning of ‘share’, 8.15–8.16 NAP Holdings case, 8.14 ‘ordinary share capital’, 8.15–8.16 ownership of voting power, 8.10 reconstructions, and, 15.4 relevant circumstances Case 1 test, 8.8 Case 2 test, 8.9 Case 3 test, 8.10 general, 8.6–8.7 requirements, 8.2–8.5 ‘share’, 8.15–8.16

Share-for-share exchanges – contd ‘sole benefit test’, 1.21 stamp taxes, 8.22 substantial shareholding exemption, and disposals, 11.4–11.5 internal reorganisations, 11.2–11.3 takeovers of public companies, 8.9 value added tax buyer’s position, 8.26–8.30 expenses incurred in another company, 8.28 hive-up, 8.30 introduction, 8.23 nominee belonging outside the EU, 8.25 registration, 8.27 seller’s position, 8.24–8.25 Target company position, 8.29 Woolcombers case, 8.13 Shareholder cross-border merger relief (TCGA, s 140G) bona fide commercial reasons, 20.56–20.58 clearances, 20.56–20.58 effect of legislation, 20.52–20.53 generally, 20.47 introduction, 20.13 qualifying conditions, 20.50–20.51 qualifying mergers, 20.48–20.49 restrictions of relief, 20.54–20.55 Shareholder reconstruction relief (TCGA, s 136) application of provision, 18.3–18.4 basic exemption, 18.5–18.6 bona fide commercial reason, 18.13 commerciality and fiscal test, 18.13–18.14 companies without share capital, 18.11–18.12 definitions, 18.9–18.10 effect of provision, 18.5–18.6 generally, 18.2 introduction, 15.4 preliminary reorganisations, 18.7–18.8 purpose, 18.2 ‘relevant holdings’, 18.9–18.10 stamp duty, 18.45 value added tax, 18.46

702

Index Sixth Company Law Directive divisions generally, 4.12 UK company law, and, 4.13 introduction, 4.10 purpose, 4.11 UK implementation, 4.14 Societas Europaea commercial considerations, 4.35 comparison with UK public companies, 4.33 compliance, 4.37 formation, 4.34 generally, 4.31 purpose, 4.32 residence, 4.36 SP 5/85 reconstructions, and, 15.6 Stamp duty see also Stamp taxes acquisition relief anti-avoidance, 2.14 generally, 2.11 insertion of new holding company, 2.12 introduction, 2.10 territorial scope, 2.13 administration, 2.6 anti-avoidance, 2.14 background, 2.1 change in economic ownership, 2.10 clearances, and, 14.20 consideration, 2.7 exchange of shares, and, 8.22 general application, 2.3 generally, 2.4 group transfer relief, 2.9 insertion of new holding company, 2.12 introduction, 2.2 payment, 2.6 reconstruction relief anti-avoidance, 2.14 generally, 2.11 insertion of new holding company, 2.12 introduction, 2.10 territorial scope, 2.13

Stamp duty – contd reliefs acquisition relief, 2.10–2.14 change in economic ownership, 2.10 generally, 2.8 group transfer relief, 2.9 reconstruction relief, 2.10–2.14 ‘return of capital’ demergers, and, 25.26 Stamp duty land tax (SDLT) see also Stamp taxes acquisition relief, 2.18 anti-avoidance clawback of reliefs, 2.21 denial of reliefs, 2.20 disclosure of tax avoidance schemes, 2.22 general rules, 2.19 background, 2.1 consideration generally, 2.16 non-market value, 2.17 disclosure of tax avoidance schemes, 2.22 general application, 2.15 group transfer relief, 2.18 reconstruction relief, 2.18 reliefs clawback, 2.21 denial, 2.20 generally, 2.18 ‘return of capital’ demergers, and transfer of Prop Co, 25.28 transfer of property to new holding company, 25.27 scope, 2.15 Scotland, in additional dwellings supplement, 2.24 anti-avoidance, 2.25 general application, 2.23 scope, 2.23 Wales, in anti-avoidance, 2.30 application, 2.26 higher residential rates, 2.28 non-residential property rates, 2.29 rates, 2.27–2.29 scope, 2.26

703

Index Stamp duty reserve tax (SDRT) see also Stamp taxes acquisition relief anti-avoidance, 2.14 generally, 2.11 insertion of new holding company, 2.12 introduction, 2.10 territorial scope, 2.13 administration, 2.6 anti-avoidance, 2.14 background, 2.1 change in economic ownership, 2.10 consideration, 2.7 general application, 2.3 generally, 2.4 group transfer relief, 2.9 insertion of new holding company, 2.12 introduction, 2.2 payment, 2.6 reconstruction relief anti-avoidance, 2.14 generally, 2.11 insertion of new holding company, 2.12 introduction, 2.10 territorial scope, 2.13 reliefs acquisition relief, 2.10–2.14 change in economic ownership, 2.10 generally, 2.8 group transfer relief, 2.9 reconstruction relief, 2.10–2.14 Stamp taxes branch incorporations, and EU, 28.31 general, 27.31 clearances, and, 14.20 company compromises or arrangements with members, and, 17.11 conversion of securities, and, 7.16 conversion of shares into qualifying corporate bonds, and, 9.37 cross-border mergers, and, 20.66 demergers, and direct demergers, 22.13, 24.113 indirect demergers, 22.17, 24.114 earn-outs, and, 10.21

Stamp taxes – contd EU branch incorporations, and, 28.31 EU cross-border demergers, and, 26.60 generally, 15.9 introduction, 2.1 liquidation distributions, and, 23.22 mergers, and, 19.31 reconstruction reliefs, and, 18.45 share capital reorganisations, and, 6.31 stamp duty, 2.2–2.14 stamp duty land tax, 2.15–2.22 stamp duty reserve tax, 2.2–2.14 Statement of Practice (SP 5/85) reconstructions, and, 15.6 Subsequent issue of shares reconstructions, and, 16.24–16.25 Substantial shareholding exemption anti-avoidance generally, 1.24 Ramsay doctrine, 1.67 assets related to shares, 1.21 company reconstruction relief, and, 18.19 conversion of QCBs, and, 11.6–11.7 extensions assets related to shares, 1.21 disposals where conditions met in previous two years, 1.22 introduction, 1.20 third subsidiary, 1.23 ‘group’, 1.19 interaction with overseas taxes, 1.26 introduction, 1.11 investee company requirements introduction, 1.15 recent reforms, 1.18 ‘trading’, 1.16 transfer of trading assets, 1.17 investing company requirements, 1.14 ‘main benefit test’, 1.24 qualifying corporate bonds, and, 11.6–11.7 recent reforms, 1.18 reconstructions, and, 18.19 relief, 1.12 reorganisations, and conclusion, 11.9 disposals, 11.4–11.5 flow chart, 11.10 internal reorganisations, 11.2–11.3

704

Index Substantial shareholding exemption – contd reorganisations, and – contd introduction, 11.1 QCB conversion, 11.6–11.7 share-for share exchanges, 11.2–11.5 simple reorganisations, 11.8 requirement, 1.12 qualifying criteria, 1.12 relief, 1.12 requirement, 1.13 scope, 1.25 share-for share exchanges, and disposals, 11.4–11.5 internal reorganisations, 11.2–11.3 ‘sole benefit test’, 1.24 ‘trading’, 1.16 transfer of trading assets, 1.17 Takeovers of public companies share-for-share exchanges, and, 8.9 Tax advantage anti-avoidance, and, 13.10 Taxation background, 1.2–1.4 capital gains tax, 1.6–1.67 conclusion, 1.68 corporation tax, 1.5 introduction, 1.1 stamp taxes introduction, 2.1 stamp duty, 2.2–2.14 stamp duty land tax, 2.15–2.22 stamp duty reserve tax, 2.2–2.14 value added tax, 3.1–3.14 TCGA, s 140 application of relief, 27.10–27.11 background, 27.3 basic conditions, 27.6–27.7 claim by transferor company, 27.8–27.9 comparison with TCGA, s 140C, 28.23 conclusion, 27.30 disposal of assets, 27.14–27.15 disposal of securities, 27.12–27.13 exceptions from charge, 27.16–27.19 exceptions for mergers, 27.24–27.25

TCGA, s 140 – contd intangible fixed assets, and, 27.28–27.29 interaction with Mergers Directive reliefs, 27.22–27.23 intra-group transactions, 27.17 introduction, 27.5 modernisation of relief, 27.4 replication of previous provisions, 27.26–27.27 restriction on double relief, 27.20–27.21 stamp taxes, 27.31 value added tax, 27.32 TCGA, ss 140A–140B branch incorporations, and anti-avoidance, 28.12–28.13 ‘appropriate conditions’ for transferee, 28.7–28.8 derivative contracts, 28.28 intangible fixed assets, 28.26 introduction, 28.3 loan relationships, 28.27 mechanism of relief, 28.9–28.10 partial divisions, and, 28.6 pre-transaction clearances, 28.13 qualifying conditions, 28.4–28.5 securities issued on division of business, and, 28.24 stamp taxes, 28.31 subsequent disposals of assets or shares or debentures, 28.11 value added tax, 28.32–28.33 EU cross-border mergers, and anti-avoidance, 26.37–26.38 ‘appropriate conditions’ for transferee, 26.33–26.34 introduction, 26.27 mechanism of relief, 26.35–26.36 partial divisions, 26.31–26.32 pre-transaction clearances, 26.38 qualifying conditions, 26.30 TCGA, ss 140C–140D branch incorporations, and anti-avoidance, 28.21–28.22 comparison with TCGA, s 140, 28.23 further reliefs, 28.29 introduction, 28.3 mechanism of relief, 28.17–28.18

705

Index TCGA, ss 140C–140D – contd branch incorporations, and – contd qualifying conditions, 28.14–28.15 restriction on double relief, 28.19–28.20 securities issued on division of business, and, 28.24 stamp taxes, 28.31 subsequent disposals of assets or shares or debentures, 28.16 value added tax, 28.32–28.33 EU cross-border mergers, and anti-avoidance, 26.47–26.48 ‘but for the Mergers Directive’, 26.44 extent to which local relief can be taken into account in computing tax charge, 26.45 introduction, 26.27 mechanism of relief, 26.42–26.43 partial divisions, 26.40–26.41 qualifying conditions, 26.39 restriction on double relief, 26.46 TCGA, s 140DA EU cross-border demergers, and, 26.49–26.51 TCGA, s 179 charges liquidation distribution, and, 23.15 return of capital’ demergers, and, 25.23 Third Company Law Directive introduction, 4.5 mergers, 4.7–4.8 purpose, 4.6 UK implementation, 4.9 Three-cornered demergers see also Demergers introduction, 22.6 Transfer by distributing company of subsidiary and issue of shares by transferee introduction, 26.19–26.20 Mergers Directive, and, 26.22 TFEU, and, 26.21 Transfer by distributing company of trade and issue of shares by transferee introduction, 26.15–26.16 Mergers Directive, and, 26.18 TFEU, and, 26.17

Transfer of assets see also EU branch incorporations generally, 28.2 introduction, 4.21 Transfer of assets to non-resident company (TCGA, s 140) application of relief, 27.10–27.11 background, 27.3 basic conditions, 27.6–27.7 claim by transferor company, 27.8–27.9 comparison with TCGA, s 140C, 28.23 conclusion, 27.30 disposal of assets, 27.14–27.15 disposal of securities, 27.12–27.13 exceptions from charge, 27.16–27.19 exceptions for mergers, 27.24–27.25 further reliefs, 28.26–28.28 intangible fixed assets, and, 27.28–27.29 interaction with Mergers Directive reliefs, 27.22–27.23 intra-group transactions, 27.17 introduction, 27.5 modernisation of relief, 27.4 replication of previous provisions, 27.26–27.27 restriction on double relief, 27.20–27.21 stamp taxes, 27.31 value added tax, 27.32 Transfer of business as going concern (TOGC) company transfers, and, 3.14 consequences of treatment, 3.13 generally, 3.12 introduction, 3.1 Transfer of business reconstruction relief (TCGA, s 139) basic relief, 18.17–18.18 bona fide commercial reason, 18.26–18.27 clearances, 18.26–18.27 collection of unpaid tax, 18.28–18.29 company law issues, 18.15–18.16 definitions, 18.30–18.31 degrouping charge, 18.22–18.23 exclusions from relief, 18.24–18.25 introduction, 15.4

706

Index Transfer of business reconstruction relief (TCGA, s 139) – contd pre-transaction clearances, 18.26–18.27 purpose, 18.15 scope, 18.20–18.21 substantial shareholding exemption, and, 18.19 Transfer of non-UK trade (TCGA, ss 140C–140D) anti-avoidance, 28.21–28.22 comparison with TCGA, s 140, 28.23 further reliefs, 28.29 introduction, 28.3 mechanism of relief, 28.17–28.18 qualifying conditions, 28.14–28.15 restriction on double relief, 28.19–28.20 securities issued on division of business, and, 28.24 stamp taxes, 28.31 subsequent disposals of assets or shares or debentures, 28.16 value added tax, 28.32–28.33 Transfer of shares in subsidiaries to members introduction, 26.12 Mergers Directive, and, 26.14 TFEU, and, 26.13 Transfer of UK business (TCGA, ss 140A–140B) anti-avoidance, 28.12–28.13 ‘appropriate conditions’ for transferee, 28.7–28.8 derivative contracts, 28.28 further reliefs, 28.26–28.28 intangible fixed assets, 28.26 introduction, 28.3 loan relationships, 28.27 mechanism of relief, 28.9–28.10 partial divisions, and, 28.6 pre-transaction clearances, 28.13 qualifying conditions, 28.4–28.5 securities issued on division of business, and, 28.24 stamp taxes, 28.31 subsequent disposals of assets or shares or debentures, 28.11 value added tax, 28.32–28.33 25% test share-for-share exchanges, and, 8.8

‘Unascertainable’ earn-outs, and, 10.16–10.17 Unit trusts intangible fixed assets relief, and, 18.40 Up-stream mergers mergers, and, 19.27 Valuation return of capital’ demergers, and, 25.9 Value added tax (VAT) branch incorporations, and EU, 28.32–28.33 general, 27.32 categories, 3.1 clearances, and, 14.21 company compromises or arrangements with members, and buyer’s position, 17.9 introduction, 17.7 seller’s position, 17.8 target’s position, 17.10 company reorganisations, and, 3.5 compliance, 3.3 conversion of securities, and company’s position, 7.19 introduction, 7.17 securities-holder position, 7.18 conversion of shares into qualifying corporate bonds, and, 9.38 costs from overseas, 3.10 cross-border mergers, and, 20.67 demergers, and see also Value added tax (demergers) direct demergers, 24.115–24.118 indirect demergers, 24.119–24.127 direct demergers distributing company’s position, 24.117 introduction, 24.115 subsidiary’s position, 24.118 ultimate shareholders’ position, 24.116 earn-outs, and, 10.22 EU branch incorporations, 28.32–28.33

707

Index Value added tax (VAT) – contd EU cross-border demergers, and introduction, 26.61 transferor company not UK resident, transferee company UK resident, 26.63 transferor company UK resident, transferee company not, 26.62 European dimension, 3.4 exchange of shares, and buyer’s position, 8.26–8.30 expenses incurred in another company, 8.28 hive-up, 8.30 introduction, 8.23 nominee belonging outside the EU, 8.25 registration, 8.27 seller’s position, 8.24–8.25 Target company position, 8.29 exempt supplies, 3.1 indirect demergers of trade distributing company’s position, 24.121 introduction, 24.119 New Co’s position, 24.122 ultimate shareholders’ position, 24.120 indirect demergers of subsidiary distributing company’s position, 24.125 introduction, 24.123 New Co’s position, 24.126 subsidiary’s position, 24.127 ultimate shareholders’ position, 24.124 input VAT, 3.2 introduction, 15.9 liquidation distributions, and distributing company’s position, 23.26 introduction, 23.23 New Cos’ position, 23.27 superimposition of New Top Co, 23.24 ultimate shareholders’ position, 23.25 mergers, and, 19.32 outline, 3.1 reconstruction reliefs, and, 18.46 reduced-rate, 3.1

Value added tax (VAT) – contd reorganisations, and consideration, 3.7 costs from overseas, 3.10 effect of grouping, 3.11 exempt fees, 3.9 fees charged by intermediaries, 3.9 generally, 3.5 input VAT recovery, 3.8 relevant business for VAT, 3.6 transfers of business as a going concern, 3.12–3.14 ‘return of capital’ demergers, and preliminary superimposition of Top Co, 25.29 treatment of demerger, 25.30 reverse charge, 3.10 share capital reorganisations, and company’s position, 6.34 introduction, 6.32 shareholder’s position, 6.33 standard-rated, 3.1 transfers of businesses as going concern company transfers, and, 3.14 consequences of treatment, 3.13 generally, 3.12 introduction, 3.1 transfers of company, 3.14 zero-rated, 3.1 Value added tax (demergers) direct demergers distributing company’s position, 24.117 introduction, 24.115 subsidiary’s position, 24.118 ultimate shareholders’ position, 24.116 indirect demergers of trade distributing company’s position, 24.121 introduction, 24.119 New Co’s position, 24.122 ultimate shareholders’ position, 24.120 indirect demergers of subsidiary distributing company’s position, 24.125 introduction, 24.123

708

Index Value added tax (demergers) – contd indirect demergers of subsidiary – contd New Co’s position, 24.126 subsidiary’s position, 24.127 ultimate shareholders’ position, 24.124 Vendor placements earn-outs, and, 10.1 increase in share capital, and, 6.13 Venture Capital Trusts disposal relief, 12.18 distribution relief, 12.17

Venture Capital Trusts – contd exchange of shares owned by individual, 12.16–12.19 exchange of shares owned by Trust, 12.15 ‘front end’ income tax relief, 12.16 introduction, 12.14 Winding up, etc reconstructions, and, 16.18–16.19

709

710