Finance Bill 2002: EXPLANATORY NOTE

CLAUSE 44 AND SCHEDULE 9:SHARE EXCHANGES
AND COMPANY RECONSTRUCTIONS

SUMMARY

1. This clause and Schedule revise provisions in the Taxation of Chargeable Gains Act 1992 (TCGA) which relate to share exchanges and certain other forms of company restructuring. These provisions allow taxpayers to defer a capital gains liability where the relevant conditions are met. The changes introduced give statutory effect to previous Inland Revenue practice, and also include a minor extension of the scope of the existing provisions.

DETAILS OF THE CLAUSE

2. Clause 44 provides for Schedule 9 to take effect, and provides a brief description of its contents.

DETAILS OF THE SCHEDULE

3. Part 1 of Schedule 9 inserts new sections 135 and 136 and Schedule 5AA into TCGA. These new provisions replace and amplify the existing TCGA provisions on share exchanges and company reconstructions. Part 2 of the Schedule makes consequential changes to other tax provisions. Part 3 contains commencement provisions.

Part 1

4. Paragraph 1 of Schedule 9 replaces the existing section 135 TCGA with a new section 135.

new section 135
Exchange of securities for those in another company

5. Subsection (1) is introductory. It explains that the section applies where one company (?company B?) acquires shares in, or debentures of, another company (?company A?) and in exchange issues its own shares or debentures.

6. Subsection (2) sets out the three sets of circumstances where section 135 applies?

Case 1 is where company B acquires as a result of the exchange, or already holds, over one-quarter of the ordinary share capital of company A.
Case 2 is where company B makes a general offer to all the shareholders in company A (or to all the shareholders of a particular class) and the offer is made on the basis that company B would gain control of company A.
Case 3 is where company B acquires as a result of the exchange, or already holds, the majority of the voting power in company A.

7. Subsection (3) provides for the rules in sections 127 to 131 TCGA, which deal with a reorganisation of a company's share capital, to apply as though company A and company B were the same company and the exchange were a reorganisation of that company's share capital. The basic effect of this is that a person who exchanges shares in, or debentures of, company A for shares in, or debentures of, company B is treated as not disposing of their old shares or debentures. Instead their old shares or debentures are treated as the same asset as their new shares or debentures, acquired as the old shares or debentures were acquired.

8. Subsection (4) provides the definition of ?ordinary share capital? which applies for the purposes of section 135. This includes units in a unit trust and interests in a company which has no share capital which are possessed by its members.

9. Subsection (5) extends the scope of section 135 to cover situations where either company A or company B has no share capital.

10. Subsection (6) makes section 135 subject to the anti-avoidance provisions in section 137.

11. Paragraph 2 of Schedule 9 replaces the existing section 136 TCGA with a new section 136.

new section 136
Scheme of reconstruction involving issue of securities

12. Subsection (1) sets out the circumstances in which the section applies. There must be a 'scheme of reconstruction? (as defined in Schedule 5AA, see paragraphs 19 to 30 below) involving an arrangement between a company (?company A?) and persons holding shares or debentures in the company. Under the arrangement another company (?company B?) must issue shares or debentures to the persons concerned, in proportion to their holdings of the shares in, or debentures of, company A (or in proportion to their holdings of the shares or debentures of the class in question).

13. Subsection (2) applies the rules in sections 127 to 131 TCGA which deal with a reorganisation of a company's share capital in a similar way to subsection (3) of section 135 (see paragraph 7 above). The persons to whom shares or debentures are issued are treated as exchanging their old holding for the new one (which may include some or all of their old holding, if it is retained instead of being cancelled, or otherwise extinguished). This deemed exchange is not treated as a disposal of the old shares or debentures. Instead the old shares or debentures are treated as the same asset as the new shares or debentures, acquired as the old shares or debentures were acquired.

14. Subsection (3) covers cases where, in order to carry out the scheme of reconstruction, company A reorganises its share capital as a preliminary step. An example is where the ordinary shares in company A are divided into two or more classes of share. Subsection (3) ensures that section 136 applies to the position after the preliminary reorganisation has been carried out.

15. Subsection (4) provides interpretation.

16. Subsection (5) extends the scope of section 136 similarly to the way subsection (5) of section 135 extends that section (see paragraph 9 above).

17. Subsection (6) makes section 136 subject to the anti-avoidance provisions in section 137.

18. Paragraph 3 of Schedule 9 inserts a new Schedule, Schedule 5AA, into the TCGA. Schedule 5AA provides the definition of a 'scheme of reconstruction? which applies for the purposes of new section 136.

Schedule 5AA
Meaning of 'scheme of reconstruction?

19. Paragraph 1 of Schedule 5AA provides that, for the purposes of section 136, a 'scheme of reconstruction? is one which meets the relevant conditions set out in the Schedule. The scheme must meet both the first and second conditions and either the third condition or the fourth condition.

20. Paragraph 2 sets out the first condition. This condition requires the relevant persons who hold ordinary shares before the reconstruction to receive ordinary shares under the scheme. In detail, a company (?the successor company?) - or companies (?the successor companies?) - must issue ordinary shares to the holders of ordinary shares (or, where relevant, to the holders of a particular class of ordinary shares) in the company, or companies, involved in the reconstruction (?the original company? or ?the original companies?). But the successor company (or companies) must not issue ordinary shares to any other person.

21. Paragraph 3 of Schedule 5AA sets out the second condition. The relevant persons must each have the same proportionate entitlement to ordinary shares in the successor company (or companies) concerned.

22. Paragraph 4 of Schedule 5AA sets out the third condition. The business previously carried on by the original company (or the businesses previously carried on by the original companies) must be carried on by one or more successor company or companies after the reconstruction. Some part of a business must be carried on by a different company after the restructuring.

23. This third condition also requires that substantially the whole of the business or businesses in question is carried on by the successor company (or companies) after the restructuring.

24. For the purposes of this third condition, sub-paragraph (3) of paragraph 4 treats a business carried on by a subsidiary company as if it were carried on by its parent company. This enables the parent company, which may be a holding company with no business of its own, to meet the third condition by reference to the business carried on by its subsidiary.

25. Also for the purposes of this third condition, sub-paragraph (4) disregards any assets which an original company retains in order to make a capital distribution to its remaining shareholders after the reconstruction has been put into effect. A case where this might arise would be one where most of a company's shareholders wish to maintain their investments in the business, but a significant minority do not. So the company transfers an appropriate part of its business to a successor company, whilst retaining sufficient assets to satisfy the rights of the remaining shareholders. It then goes into liquidation, realises the value of the assets it retained, and pays off the remaining shareholders with the proceeds. (This will be a disposal by these remaining shareholders for capital gains purposes, and any gain on the disposal will be chargeable to tax.)

26. Paragraph 5 of Schedule 5AA sets out the fourth condition which must be met if the third condition is not. There are two requirements. First, the scheme must be effected either in accordance with the relevant provisions for reconstructing a company in the Companies Act 1985 (or the corresponding provisions for companies in Northern Ireland), or under the equivalent law of a country or territory other than the UK. Second, the company (or companies) which is (or are) subject to the scheme of reconstruction must retain the whole of the business which it (or they) carried on before the scheme was put into effect.

27. Paragraph 6 of Schedule 5AA corresponds to the provision in section 136(3) (see paragraph 14 above). It ensures that Schedule 5AA applies to the position after any preliminary reorganisation has been carried out.

28. Paragraph 7 of Schedule 5AA provides an equivalent ?cut-off? after the restructuring has been put into effect. Any issue of shares or debentures by a successor company which is made after all the shares or debentures to be issued in the restructuring have been issued is not taken into account in establishing whether there is a 'scheme of reconstruction? as defined in Schedule 5AA.

29. Paragraph 8 of Schedule 5AA provides interpretation.

Part 2

30. Paragraphs 4, 5 and 6 of Schedule 9 amend various provisions in the Income and Corporation Taxes Act 1988, in the TCGA, and in the Corporate Venturing Scheme provisions in Schedule 15 to the Finance Act 2000. These amendments are all required as a consequence of the replacement of sections 135 and 136 TCGA with the new sections 135 and 136.

Part 3

31. Paragraph 7 provides for the new sections 135 and 136 and Schedule 5AA in TCGA, and the amendments in paragraphs 4, 5 and 6, to take effect in relation to shares or debentures issued on or after 17 April 2002. This is subject to paragraph 8.

32. The general commencement provision in paragraph 7 is modified by paragraph 8 in relation to some of the consequential amendments.

BACKGROUND

33. For capital gains purposes, shareholders in a company which is taken over are treated as not disposing of their shares at the time of the take-over, provided certain conditions are met. Similar treatment applies to holders of debentures of a company. The treatment also applies to certain other forms of corporate restructuring.

34. A recent High Court case (Fallon and Kersley v Fellows) has established that some types of corporate restructuring, which were previously accepted by the Inland Revenue as meeting the conditions for this ?no disposal? treatment, do not in law satisfy them.

35. The new provisions in Schedule 9 reverse the effect of the High Court decision, and also put other forms of corporate restructuring on a firm statutory footing. These changes allow share and debenture holders to continue to benefit from the ?no disposal? treatment in all circumstances which were previously accepted as qualifying for it.

36. The new provisions also extend the ?no disposal? treatment to certain circumstances where it was not previously available, because the relevant company did not have a share capital, or because the transactions were in units in a unit trust.

37. The opportunity has also been taken in the Schedule to clarify other parts of the provisions relating to take-overs and corporate restructurings.