Finance Act 2011 included several provisions simplifying the avoidance rules for corporate capital gains, following on from consultations during 2009 and 2010. They covered three areas:
- value shifting – simplifying the existing legislation and restricting its application to disposals of shares or securities which have been materially reduced in value. A six year time limit is also introduced for the application of depreciatory transaction rules.
- de-grouping charges – changing the provisions so that the charge increases consideration for the disposal of shares, so that in cases where the substantial shareholding exemption applies, there will in fact be no degrouping charge. Also, groups organised on a divisional basis will not be penalised where assets are transferred to a newly formed company prior to disposal. The legislation will also be clarified to make clear that companies need to be members of the same group at all times between the transfer of the asset and on de-grouping in order to avoid a de-grouping charge.
- capital losses on a change of ownership – simplifying the avoidance rules for acquired losses and relaxing their application to take account of how businesses operate in a group environment when distressed businesses are acquired.
These Finance Act 2011 provisions generally took effect from 19 July 2011. However in relation to the changes to de-grouping provisions it was possible to make an election for them to apply with effect from 1 April 2011.
The previous value shifting provisions in TCGA92 s30-34 remain in existence until 19 July 2011 (see s44 and schedule 9 FA2011). Those provisions were mechanical in their attack on avoidance of gains where there was a shift in value prior to disposal, and they had no tax avoidance purpose filter.
Their application in the case of groups of companies was restricted for certain group transactions, but this could reduce a loss or increase a gain. However there was overlap with the rules in the TCGA92 s176 'depreciatory transaction' legislation. The depreciatory legislation eliminates a loss where it applies, but cannot increase a gain, and also applies without any tax avoidance purpose filter. It was previously accepted that a pre-sale dividend paid out of post acquisition profits was not caught by TCGA92 s176 (HMRC manual reference CG46580).
The legislation in Finance Act 2011 reorganised the value shifting provisions that apply for companies into a new s31 (amending s30 and replacing the existing s31-34). The new rules are restricted to disposals of shares in, or securities of, another company where:
- arrangements have materially reduced the value;
- tax avoidance (in relation to CT on chargeable gains) is the main or one of the main purposes of the transaction; and
- the arrangements do not relate to the making of an exempt distribution.
The depreciatory provisions at TCGA92 s176 remain unaltered, apart from cross referencing and the introduction of a six year time limit between the depreciatory transaction and the date of disposal, after which they no longer apply.
The changes apply to company disposals of shares or securities made on or after 19 July 2011. HMRC guidance on the changes is included at CG48500 to CG48560 and includes an example of a company with distributable reserves but no cash to pay a dividend (example 6 on CG48560). The company borrows money to pay a dividend equal to the distributable reserves. This is held to be normal commercial practice and despite the fact that this includes "arrangements" (the loan) in addition to the making of an "exempt distribution", tax avoidance is not the main purpose and this is in HMRC's view (contrary to their earlier suggestion) not caught by the new TCGA s31.
A further condition has been added where a later de-grouping charge under TCGA92 s179 could apply, that has effect in relation to a company ceasing to be a member of a group on or after 23 March 2011 (Finance Act 2011 s31). Previously it was possible to avoid a de-grouping charge where the two group companies concerned were transferred together to another group that was connected with the original group and the connection between these groups was broken. The added provision amend s179(2A) and add s179(2AA) to include this circumstance to the set of situations where the s179 charge is potentially triggered.
Until the application date for the de-grouping rules introduced by FA2011 (see below), the previous degrouping charges in TCGA92 s179 applied and led to problems in the following situations:
- the administration burden of the six year time limit, particularly after several mergers and acquisitions;
- the tax charge fell on the company leaving the group, though the economic gain was to the group from which the company was leaving;
- potential economic double taxation – once on the asset and then again on a subsequent share sale;
- complexities where single asset companies were used and there were transfers around a group (as with property assets for example);
- the fact that a de-grouping charge could arise when the share sale qualified for substantial shareholding exemptions (SSE) where the intention of the SSE was that the sale of a trading company should be free of tax. This problem could be particularly difficult where a business was organised along divisional lines and some reorganisation was required in order to parcel up a business for a corporate disposal;
- the need to retain a company as a dormant company for six years in order to avoid a de-grouping charge after a reorganisation transferring its business and assets to other group companies, where an associated company was sold containing an asset that had been transferred as part of the reorganisation. In addition taxpayers were not clear how the provision preventing a double charge works, as highlighted in the 2008 Johnston Publishing (North) Ltd Court of Appeal case [EWCA Civ 858].
The changes introduced in Finance Act 2011 generally take effect from 19 July 2011. However a revocable election could be made for the new rules on degrouping charges to apply from 1 April 2011. The election had to be made or revoked no later than 31 March 2012, and required the consent of any member that left the group between 1 April 2011 and 19 July 2011. The changes have the following effects:
- the six year time limit in TCGA92 s179 remains;
- s179(2) is replaced to clarify that the de-grouping charge will be disapplied where two companies are in the same subgroup at all times between the date of transfer of an asset from one to the other until immediately after both leave the original group (this same exception is to be introduced for the degrouping charge under the intangible asset regime). An equivalent clarification is made to the intangible asset regime (principally CTA09 s783);
- the de-grouping tax charge applies by increasing the share disposal proceeds where the de-grouping is by way of a disposal of shares, rather than a separate CGT charge. Where there is a share for share exchange and TCGA92 s127 would apply to treat the transaction as not involving a disposal, s127 will be ignored for the purpose of s179 (this will mean that share for share reorganisation transactions are not unfairly disadvantaged compared to cash disposals by the new provisions). Where there is more than one group disposal of the company (for example the disposal is staged over time) there is also a facility for making an election to allocate the gain (or loss) between the various transferors according to the election. If no election is made, the gain (or loss) is divided equally (proportionately) between the different group disposals. The election must be made within 2 years of the end of the accounting period in which any chargeable gain or allowable loss first accrues on a group disposal. This means that there will no longer be a problem where the SSE applies, as the de-grouping charge will increase the disposal proceeds to be exempt under the SSE;
- where the de-grouping charge arises otherwise than by a disposal of shares (for example by an issue of new shares), then the de-grouping charge would be a stand-alone charge in the asset holding company as at before;
- to prevent economic double taxation there is a provision for reduction on a just and reasonable basis (new s179ZA), though any reduction is carried through to reduce the market value figure applied to any reacquisition by "company A";
- where assets are transferred around a group prior to disposal and the SSE would apply but for satisfying the time limit in relation to the transfer, the SSE time limit condition would be treated as though the shares were held by the investing company at any time in the final 12 month period when the asset was previously used by a member of the group. This will mean that divisionalised activities can be transferred to newly incorporated companies of a group and the SSE can apply if the SSE time limits are met in relation to that division. However corresponding changes are not being introduced to the intangible asset regime, so there may still be de-grouping charges in respect of intangible assets where otherwise the SSE would apply. Note the new rules for divisions do not apply to a single company as there must be a group in existence for at least 12 months (Sch7AC para 15A);
- TCGA92 s179A, 179B and Sch7AB have been withdrawn, as the business asset roll over relief provisions are deemed to be sufficient to deal with any gains realised on disposal of trade assets.
Some potential areas for concern with these changes include the following:
- TGCA92 s179B, permitting a roll over relief claim for gains arising on deemed disposals and reacquisitions, has been repealed. This will mean that where a degrouping charge arises because a company leaves a group without a disposal of shares (for example on a paper for paper exchange, or if entitlement to profits change so that it becomes a member of another group), there will be no possibility of rolling over that gain on the acquisition of new assets.
- The substantial shareholding exemption does not affect any charge that might arise under the intangible asset regime, so that where an intangible asset of a divisional activity is parcelled up into a company for sale, there could still be a degrouping charge under the CTA09 intangible asset regime (as both companies concerned will not have left the group together). Thus the amendments enabling a division to be parcelled up with the avoidance of de-grouping charges because of the substantial shareholdings exemption, may still have an intangible asset de-grouping charge.
Capital losses on a change of ownership
Prior to 19 July 2011, TCGA92 s177A and Sch 7A limited the scope for an acquirer to offset losses accruing to an acquired company against gains on other group assets. That legislation was mechanical in its application and has no purpose test. TCGA92 s184A was introduced in 2006 to counter avoidance schemes which circumvented Sch 7A where the aim of the transactions was to secure a tax advantage through access to unrealised losses on "pre-change" assets.
The changes in Finance Act 2011 removed those parts of Sch 7A that referred to losses realised post acquisition on 'pre-entry assets', as these are covered by s184A.
Sch 7A was also limited in that pre-entry losses could only be offset against gains on assets used for a preentry trade. This restriction is relaxed so that pre-entry losses can be used against gains on assets used in a pre-entry 'trade' or 'business'. A further change removed the restriction that the same company had to carry on the business after the change in order to use the losses. It is now sufficient that the business is carried on somewhere in the group.
The new rules came into force on 19 July 2011. The pre-entry portion of unused losses realised since acquisition on pre-entry assets are treated as if they were realised immediately before the company became a relevant group member, on commencement of the new rules (so that the new rules apply to that portion of the loss as if it was a pre-entry loss at the date of acquisition of the company by the group).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.