Finance Bill 2002: EXPLANATORY NOTE
CLAUSE 43 AND SCHEDULE 8: EXEMPTIONS FOR DISPOSALS BY COMPANIES WITH SUBSTANTIAL SHAREHOLDING
SUMMARY
1. Clause 43 and Schedule 8 introduce into the Taxation of Chargeable Gains Act 1992 (TCGA) an exemption regime for gains and losses arising on disposals by companies of substantial shareholdings. The exemption will apply to most disposals by trading companies of shareholdings of 10% or more in other trading companies.
2. Schedule 7AC TCGA, which is introduced by Schedule 8, contains the main provisions. It introduces three exemptions for companies disposing of shares, an interest in shares or an asset which, for the purposes of the Schedule, is related to shares.
3. The main exemption applies in relation to disposals by trading companies or members of trading groups of all or part of a substantial shareholding in another trading company or the holding company of a trading group or sub-group. To have a substantial shareholding a company must have owned at least 10% of the ordinary shares in another company for a continuous period of 12 months during the two years before the disposal. The effect of the exemption is that any gain on the disposal is not chargeable to tax and any loss is not available to be set off against gains.
4. One of the subsidiary exemptions applies where the requirements for the main exemption are met and a company disposes of an asset related to shares in the company in which the substantial shareholding is owned. Broadly speaking, assets are related to shares in a company if they are options over, or securities convertible into or exchangeable for, shares in that company.
5. The second subsidiary exemption applies where the conditions for the other exemptions are not met at the time of the disposal, but a disposal within the previous two years would have qualified for the main exemption and certain conditions are satisfied.
6. There are special rules to cover groups of companies, where more than one member may hold shares in the same company, and special rules for life insurance companies. The Schedule also contains detailed rules for establishing whether companies or groups are trading.
DETAILS OF THE CLAUSE
7. Subsection (1) inserts a new section, section 192A, into the Taxation of Chargeable Gains Act 1992 (TCGA), which gives effect to a new Schedule, Schedule 7AC, to that Act (see paragraphs 13 to 71 below).
8. Subsection (2) gives effect to Schedule 8 to the Finance Bill.
9. Subsection (3) provides for Clause 43 and Schedule 8 to have effect in relation to disposals on or after 1st April 2002.
10. Subsection (4) sets out the commencement provision for a measure in Schedule 7AC to the TCGA which modifies the effect of section 179 of the TCGA. Section 179 can impose a tax charge where companies cease to be members of groups in certain circumstances where a departing company holds assets which it acquired from another member of its group. The measure in question is described in paragraph 70 below.
11. Subsection (5) provides the commencement provision for an amendment made to section 179 of the TCGA by Schedule 8 to the Bill (see paragraph 72 below).
DETAILS OF SCHEDULE 8
Part 1: New Schedule 7AC to the Taxation of Chargeable Gains Act 1992
12. Paragraph 1 of Schedule 8 inserts Schedule 7AC into the TCGA.
Schedule 7AC Taxation of Chargeable Gains Act 1992: Exemptions for disposals by companies with substantial shareholding
Part 1 - The exemptions
13. Paragraph 1 provides the main exemption: a gain arising to a company on a disposal of shares, or an ?interest in shares? (see paragraph 29 of Schedule 7AC), in another company is not a chargeable gain if the requirements of Parts 2 and 3 of Schedule 7AC are met, and the circumstances mentioned in paragraphs 5 and 6 of the Schedule do not apply. This also has the effect that a loss arising in such circumstances is not allowable as a deduction against gains. This is by virtue of section 16(2) of the TCGA, which provides that a loss is not allowable if a gain arising in the circumstances in question is not chargeable.
14. Paragraph 2 provides for a gain on an ?asset related to shares? (see paragraph 30 of Schedule 7AC) not to be a chargeable gain where the investing company (or another member of its group) holds shares or an interest in shares in the company invested in, a gain on the disposal of which would itself be exempt under the terms of the main exemption. This is subject to the exclusions mentioned in paragraphs 5 and 6 of Schedule 7AC.
15. For example, where a company holds shares, a gain on which would be exempt under the main exemption if the shares were disposed of, and also holds a security which is exchangeable into shares of the company invested in, any gain on a disposal of the security is exempt (and any loss is not allowable).
16. Paragraph 3 contains a further exemption. It is intended both to exempt certain gains which would not otherwise qualify for an exemption, for example gains made while the company invested in is in liquidation, and to provide protection against losses being made allowable which would previously have fallen within an exemption. It applies in certain cases where the conditions for the main exemption are not met at the time of disposal, but would have been met had the disposal taken place at some time in the previous two years. This is subject to the exclusions mentioned in paragraphs 5 and 6 of Schedule 7AC. The provision is couched in terms of company A disposing of shares, or an interest in shares, or an asset related to shares, in company B.
17. Sub-paragraphs (1) and (2) provide that if?
- company A meets the 'substantial shareholding requirement? (see paragraph 7 of Schedule 7AC) at the time it disposes of shares in company B,
- a gain on the disposal would be a chargeable gain (or a loss an allowable loss),
- company A is UK resident, or, if not, any gain arising on the disposal would form part of its chargeable profits for corporation tax purposes, and
- a gain on a hypothetical disposal within the previous two years of shares in company B by company A or a company in the same group would not have been a chargeable gain,
then any gain on the disposal is not a chargeable gain (and any loss is not an allowable loss).
18. This is subject to a proviso where the requirements in paragraph 19 of Schedule 7AC (relating to the company invested in) are not satisfied at the time of the disposal. In such a case the exemption applies only if there was a time within the two year period ending with the disposal when company B was controlled by?
- company A (possibly together with connected persons), or
- another company (possibly together with connected persons) which at some time during that period was a member of the same group as company A.
19. Thus, for example, where the company invested in ceases to trade on being placed in liquidation, any gain accruing to the investing company on a disposal of shares in that company in the following two year period is potentially exempt under this paragraph. And where the trade of the company invested in is transferred elsewhere (within a group, for example), any loss on the disposal by the investing company on shares in that company within the two year period after the company invested in ceased to be a trading company is potentially not allowable.
20. Sub-paragraph (3) prevents the exemption in paragraph 3 from applying if the only reason that the main exemption does not apply is that the investing company does not meet the post-disposal trading requirement in paragraph 18(1)(b) of Schedule 7AC. Sub-paragraph (3) does not have this effect if the failure to meet the condition in paragraph 18(1)(b) is due to the actual or imminent winding up or dissolution of the investing company (provided that where this is imminent, it actually takes place as soon as is reasonably practicable in the circumstances).
21. Sub-paragraph (4) provides that the post-disposal trading requirements for the investing company and the company invested in are to be assumed to be met in relation to the hypothetical disposal referred to in sub-paragraph (2)(d) (see paragraph 17 above).
22. Sub-paragraph (5) prevents the exemption in paragraph 3 applying to a gain (but not a loss) where value has been transferred into the company invested in during the two year period prior to the disposal. Otherwise for a company that has ceased trading, it would be possible to transfer a valuable asset into that company under the protection of gifts relief, sell the shares and claim that any resulting gain is exempt under this Schedule.
23. Sub-paragraph (6), in effect, disregards any vesting of company B's assets in a liquidator for the purposes of sub-paragraph (5) by providing that sub-paragraph (5) applies as if the assets were vested in the company. This means that company B is still treated as holding any asset gifted to it before the liquidator was appointed, thus allowing the condition in sub-paragraph (5)(a) to be satisfied.
24. Sub-paragraph (7) provides that where the disposal is made under a conditional contract, the condition is ignored for the purposes of deciding when the two year period referred to in paragraph 3 ends, so that the time of entering into such a contract is treated as the time of disposal.
25. Paragraph 4 switches off the various 'stand in shoes? provisions (which apply in relation to share exchanges, demergers etc) in certain circumstances. Where a gain or loss would arise if those stand in shoes provisions did not operate, and the gain would not be chargeable or the loss not allowable, under the provisions of paragraphs 1, 2 or 3 of Schedule 7AC, the stand in shoes provisions are disapplied. The stand in shoes provisions are not disapplied, however, if this would cause the investing company to lose investment relief under the Corporate Venturing Scheme.
26. This provision enables shares to benefit from the exemption in circumstances where the shares or securities received in exchange may not satisfy the requirements for a gain to be exempt on a subsequent disposal. So the stand in shoes provisions, if they were not disapplied, would mean that the deferred gain on the original shares would become chargeable on the disposal of the shares or securities that were exchanged for them. Disapplying the stand in shoes provisions means that the company does not lose out because of the share exchange.27. Paragraph 5 is an anti-avoidance measure whose purpose is to prevent a company from indirectly realising untaxed income or gains by way of a disposal that would otherwise benefit from an exemption in Part 1 of the Schedule. The effect of paragraph 5 is to prevent any of the exemptions in Part 1 from applying to the disposal.
28. Certain circumstances must be present before the provision can apply: one company makes a gain on a disposal of shares (or an interest in shares, or an asset related to shares) in another company at a time when the first company controls, or has previously controlled, the second company, or when both companies are, or have been, under common control. Additionally, the gain, except possibly for a part of it which is not substantial, represents untaxed profits. If these circumstances occur in pursuance of, or as a result of, arrangements from which the expected sole or main benefit was a tax-free gain on the disposal, then paragraph 5 applies.
29. Profits for these purposes means realised or unrealised income or gains. Such profits are untaxed if they are not brought into account for the purposes of tax on profits, whether in the UK or elsewhere, for a period ending on or before the date of the disposal of the shares etc. However, such profits are not untaxed if an amount representing those profits has been apportioned to, and is chargeable on, a UK resident company under the UK's Controlled Foreign Company regime for an accounting period ending on or before the date of disposal.
30. Paragraph 6 performs three functions. It?
Part 2 - The substantial shareholding requirement
31. Paragraph 7 provides that the investing company must have held a substantial shareholding in the company invested in throughout a 12 month period beginning not more than two years prior to the date of the disposal. So part disposals out of a substantial shareholding can continue to qualify for a further 12 months (provided all the other conditions are met), notwithstanding that the 10% threshold (see paragraph 8 of Schedule 7AC) has ceased to be satisfied.
32. Paragraph 8 sets out the meaning of a substantial shareholding. The investing company must hold at least 10% of the ordinary share capital of the company invested in and be beneficially entitled to at least 10% of?
33. The rules in Schedule 18 ICTA are imported in a slightly modified form to determine what is meant by ?equity holder? and to determine the profits or assets available for distribution.
34. Paragraph 9 applies for the purposes of deciding whether a company that is a member of a group holds a substantial shareholding - shares held by group members are aggregated (except in the case of shares held in the long-term insurance fund of a group member which is a life insurance company). This also applies to interests in shares. (See paragraph 26 of Schedule 7AC for the definition of a group).
35. Paragraph 10 deals with the situation where there has been a no-gain/no-loss transfer by which the company acquired the shares. The period for which a company is treated as having held the shares for the purposes of Part 2 of Schedule 7AC is extended back through any series of no-gain/no-loss transfers by means of which the shares, or shares from which they are ?derived? (within the meaning of sub-paragraph (6)), have arrived in the hands of the present company. The company is also treated for those purposes as having had the entitlements provided by those shares, and any entitlements or holdings which would accordingly have been attributed to it under the group aggregation rules, in relation to those prior periods. (This also applies to interests in shares.) The meaning of ?no-gain/no-loss transfer? (see paragraph 30 above) is extended for this purpose to include intra-group share exchanges which would qualify for no-gain/no-loss treatment were it not for the fact that the 'stand in shoes provisions? (see paragraph 25 above) applied to the exchange.
36. Paragraph 11 provides that the holding period for a substantial shareholding is terminated (and a new period started) by a deemed disposal and reacquisition under any of the provisions relating to corporation tax.
37. Paragraph 12 deals with the effect of sale and repurchase agreements (repos). The original owner of the shares entering into a repo is treated as continuing to be the owner. By the same token, the purchasing counterparty is treated as not holding the shares and not being entitled to any rights attached to them. To prevent exploitation of this provision, the rules provide that where the original owner, or another member of the same group, becomes the actual owner of the shares at any time during the period the repo is current (i.e. the shares have ?gone round in a circle?) the approach described above ceases to apply at that time.
38. Paragraph 13 is a companion paragraph to paragraph 12 of Schedule 7AC but dealing with stock lending, rather than repos. Its approach is identical.
39. Paragraph 14 sets out how the substantial shareholding requirement (see paragraph 31 above), as it applies in relation to the company invested in, is to apply where there has been an earlier share exchange under section 135 of the TCGA or a deemed share exchange under section 136 of the TCGA. It provides for transparency through the exchange.
40. For example, suppose company A holds shares in company B. The shares in company B are acquired by company C in exchange for an issue of shares in company C to company A. Company A later sells the shares in company C. For the purposes of testing whether the substantial shareholding requirement is met in relation to the company invested in, company A's shareholding in company C is relevant for the period following the share exchange, and its shareholding in company B is relevant for the period prior to the exchange.
41. Paragraph 15 provides equivalent treatment to that provided by paragraph 14 of Schedule 7AC where shares in a subsidiary have been demerged. For example, suppose company Z holds shares in a parent company, the parent company distributes the shares in a subsidiary to its shareholders and section 192(2) of the TCGA applies so that the shares in the subsidiary are treated as though they were received in a company reorganisation. When company Z subsequently sells the shares in the subsidiary, the substantial shareholding requirement, as it applies in relation to the company invested in, is tested by reference to the subsidiary back to time of the distribution and to the parent prior to that point.
42. Paragraph 16 covers the circumstance where the investing company, or another member of the same group as the investing company, is in liquidation. In effect, it prevents the company in liquidation from losing beneficial ownership of its assets as a result of those assets being vested in a liquidator by treating those assets as being vested in the company (and the acts of the liquidator as being the acts of the company) for the purposes of Part 2 of Schedule 7AC. Without this provision, the appointment of a liquidator could cause a company to cease to satisfy the necessary conditions for an exemption under Part 1 of the Schedule.
43. Paragraph 17 modifies the basic rule for what is a substantial shareholding (see paragraph 32 above) for the case where the investing company is a life insurance company (or a 51% subsidiary of a life insurance company) and the shares are held as an asset of its long-term insurance fund. The 10% threshold is replaced by a 30% threshold to ensure that the exemptions in Part 1 of Schedule 7AC do not apply to the wider range of portfolio shareholdings that life companies are likely to hold. The reason that 51% subsidiaries are covered is that there would otherwise be scope for insurance companies to benefit from the exemption in relation to portfolio investments by holding them indirectly through investment companies (so that the 30% test would be satisfied by holding the whole of that company's shares within the long-term insurance fund).
Part 3- Requirements to be met in relation to investing company and company invested in
44. Paragraph 18 provides that the investing company must have been either a 'sole trading company? (defined in sub-paragraph (6)), or a member of a ?qualifying group? (see paragraph 46 below), throughout the period?
- beginning with the start of the latest 12 month period (within the period of 2 years prior to the disposal) in relation to which the investing company met the substantial shareholding requirement (see paragraph 7 of Schedule 7AC) in relation to the company invested in, and
- ending with the time of the disposal.
45. The investing company must also be a sole trading company or member of a qualifying group immediately after the disposal.
46. A ?qualifying group? is a ?trading group? (see paragraph 21 of Schedule 7AC) or a group that would be a trading group if the ?not for profit? activities of any group member that was not established for profit were disregarded.
47. Sub-paragraph (4) provides for the requirement mentioned in paragraph 44 above to be treated as satisfied if, at the time of disposal, the investing company is a group member that does not itself satisfy the condition, but there is another group member which would satisfy it if:
- the shares (or interest in shares or asset related to shares) in question had been transferred to that other company immediately prior to the disposal;
- the transfer would qualify for the no-gain/no-loss treatment in section 171(1) of the TCGA, and
- that other company were to have made the disposal.
The effect is that groups do not lose out where, for example, shares are transferred intra-group to a newly-formed subsidiary which disposes of them shortly after coming into existence.
48. Sub-paragraph (5) provides that where the disposal is made under a contract, so that under section 28 of the TCGA the time of the disposal is different from that of the actual conveyance or transfer, the requirements mentioned in sub-paragraph (1)(a) and (b) must also be satisfied in relation to the time of the transfer or conveyance.
49. Paragraph 19 provides that the company invested in must have been a ?qualifying company? (see paragraph 51 below) throughout the period mentioned in paragraph 44 above.
50. It must also be a qualifying company immediately after the disposal.
51. A ?qualifying company? is defined as a ?trading company? (see paragraph 20 of Schedule 7AC) or the ?holding company? (see paragraph 26(3) of Schedule 7AC) of a ?trading group? (see paragraph 21 of Schedule 7AC) or ?trading subgroup? (see paragraph 22 of Schedule 7AC).
52. Where the disposal is made by way of a contract, the rule described in paragraph 48 above applies in relation to the requirements mentioned in paragraphs 49 and 50 above.
53. Paragraph 20 provides the definition of ?trading company? which applies for the purposes of Schedule 7AC. A ?trading company? is a company carrying on ?trading activities? whose activities do not to any substantial extent include activities that are not trading activities. ?Trading activities? include, for this purpose, activities carried on by the company with a view to its acquiring a trade or a trading subsidiary, or a qualifying interest in a joint venture company but only if the acquisition is made as soon as reasonably practicable in the circumstances.
54. Paragraph 21 defines a ?trading group? for the purposes of Schedule 7AC as a group one or more of whose members are carrying on trading activities and whose activities taken together (disregarding intra-group activities) do not to any substantial extent include activities that are not trading activities. ?Trading activities? include, for this purpose, activities carried on by any member of the group with a view to its acquiring a trade or an interest in a trading company which is not a member of the group, but only if the acquisition is made as soon as is reasonably practicable in the circumstances and, in the case of the acquisition of an interest in a trading company, the company in question becomes a member of the group as a result of the acquisition.
55. Paragraph 22 provides a corresponding definition of ?trading subgroup? for the purposes of Schedule 7AC.56. Paragraph 23 sets out how a company's holdings in ?joint venture companies? are treated to determine whether it is a trading company, a member of a trading group, or the holding company of a trading group or trading subgroup for the purposes of Schedule 7AC. A ?joint venture company? is defined in paragraph 24 as a trading company or a holding company where there are five or fewer persons who between them hold 75% or more of its ordinary share capital. For this purpose, the members of group are, in effect, treated as being a single company as far as their holdings in a joint venture company are concerned.
57. The rules provide a transparent treatment where a company has a ?qualifying shareholding? in a joint venture company. A ?qualifying shareholding? is defined in paragraph 24 of Schedule 7AC as a holding of at least 10% of the joint venture company's ordinary share capital. The holdings of the members of a group are aggregated for the purpose of deciding whether the 10% requirement is met. The effect of the treatment is to disregard the investing company's holdings of shares and securities in the joint venture company and treat the investing company as though it were carrying on the appropriate proportion of the underlying activities of the joint venture company.
58. Paragraph 25 applies the provisions in paragraphs 14 and 15 of Schedule 7AC (the effects of earlier company reconstruction or demerger) for the purposes of paragraph 19 of the Schedule (see paragraphs 49 to 52 above).
Part 4 - Interpretation
59. Paragraphs 26 to 28 provide interpretation of the terms used in Schedule 7AC: ?company?, ?group? and related expressions (paragraph 26); ?trade? (paragraph 27); and ?twelve-month period? (paragraph 28).
60. Paragraph 29 defines what is meant by an ?interest in shares? for the purposes of Schedule 7AC. An ?interest in shares? is an interest in shares as a co-owner of shares.
61. Paragraph 30 sets out the meaning of an ?asset related to shares? in a company for the purposes of Schedule 7AC. These include?
- an option to acquire or dispose of shares in the company, and
- a security that is convertible or exchangeable into those shares and an option to acquire or dispose of such a security.
62. Paragraph 31 provides an index of defined expressions.
Part 5 - Consequential provisions
63. Paragraph 32 ensures that any exemption provided by Schedule 7AC is disregarded in determining whether shares are ?chargeable shares? or an asset is a ?chargeable asset? for the purposes of corporation tax or capital gains tax. So that, for example, shares that are within the exemption can still count as ?chargeable assets? for the purposes of the Corporate Venturing Scheme requirement in paragraph 13 of Schedule 15 to Finance Act 2000.
64. Paragraph 33 modifies the way in which a negligible value claim can be made under section 24(2) of the TCGA. Where Schedule 7AC would result in a loss on a disposal at the time of the claim not being an allowable loss, the company may not backdate the deemed disposal to an earlier time.
65. Paragraph 34 prevents the exemptions under Schedule 7AC applying to a postponed chargeable gain or allowable loss that is revived by virtue of section 116(10) of the TCGA. Paragraph 34 comes into play only where section 116(10) actually applies and so it is not relevant where paragraph 4(3)(a) of Schedule 7AC disapplies that provision. Paragraph 34 does not apply where the gain or loss arising under section 116(10) is a revived gain or loss which was postponed on a deemed disposal under section 92(7) of Finance Act 1996, which is concerned with convertible securities.
66. Paragraph 35 applies where the charge on a gain has been postponed on the transfer of assets to a non-resident company in exchange for shares or securities of the non-resident company. Under section 140(4) of the TCGA the charge is postponed until the subsequent disposal of the shares or securities of the non-resident company. Without this paragraph, the postponed gain (which relates to an underlying asset, rather than the shares themselves) would also be exempt. The paragraph ensures that the postponed gain can be brought into charge.
67. Paragraph 36 deals with the situation where shares are appropriated by a company as trading stock. It ensures that where the gain on the shares is exempt as a consequence of Schedule 7AC, the company is treated as acquiring the shares at market value for the purposes of computing the profits of the trade to which they are appropriated.
68. Paragraph 37 ensures that gains that held over in respect of claims to gift relief are not exempted under Schedule 7AC.
69. Paragraph 38 modifies the operation of the ?degrouping charge? in section 179 of the TCGA. The degrouping charge arises when a company leaves a group owning an asset that it acquired within the previous six years on a tax neutral basis from a fellow group member. The effect of section 179 is that the asset is deemed to have been disposed of and reacquired at market value immediately after the intra-group transfer.
70. Paragraph 38 modifies the timing of the deemed disposal under section 179 where any gain on the re-timed deemed disposal would be exempt under Schedule 7AC. In these circumstances, the section 179 deemed disposal is re-timed to take place immediately before the company owning the asset ceases to be a member of the group in cases to which section 179(3) applies and immediately before the ?relevant time? (as defined in sub-paragraph (2)(a)) where section 179(6) applies.
71. Paragraph 39 prevents a gain or loss from being treated as arising under the FOREX matching regulations made under Schedule 15 to Finance Act 1993 on a disposal which qualifies for an exemption in Part 1 of Schedule 7AC.
Part 2: Consequential amendments
72. Paragraph 2 of Schedule 8 to the Finance Bill makes a small change to the wording of section 179(4) of the TCGA to bring the drafting into line with that used in section 179(8).
73. Paragraph 3 amends section 241 of the TCGA (which deals with the tax treatment of furnished holiday lettings) by adding Schedule 7AC to the list of provisions for which the commercial letting of furnished holiday accommodation is treated as a trade.
74. Paragraph 4 inserts a new paragraph, paragraph 16, into Schedule 7B to the TCGA, which modifies (in relation to overseas life insurance companies) the reference to section 10(3) of the TCGA which appears in paragraph 3(2)(c)(ii) of Schedule 7AC.
75. Paragraph 5 inserts cross-references to paragraph 4 of Schedule 7AC in two Corporate Venturing Scheme provisions which apply in certain circumstances where a company which has been invested in becomes a subsidiary of a new holding company on an exchange of shares and securities.
BACKGROUND NOTE
76. The exemption regime for substantial shareholdings is being introduced to enable UK-based companies and groups to restructure flexibly and rapidly in response to emerging global opportunities without facing the prospect of a large tax charge. Consultation on a relief for substantial shareholdings began in June 2000, when a deferral regime was under consideration. There was further consultation in November 2000 and July 2001, during the course of which the focus shifted from deferral to an exemption regime. In November 2001, the Inland Revenue published for comment a Technical Note containing draft clauses for an exemption regime. Further draft clauses were published on 26th March reflecting the outcome of the consultation.