Finance Bill 2002: EXPLANATORY NOTE
CLAUSE 46 AND SCHEDULE 10: TAPER RELIEF: MINOR AMENDMENTS
SUMMARY
1. This clause and Schedule amend capital gains tax (CGT) taper relief:
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for disposals of shares in a close company from 17 April 2002, a change of activity by the company will no longer restrict taper relief; instead taper relief will not be available for periods when a close company is inactive;
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more debentures will be treated as securities, making them more likely to attract business assets taper relief for disposals from 6 April 2001; revenue protection measures will affect those debentures only for disposals and holdings from 17 April 2002; and
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for disposal and periods of ownership from 17 April 2002, some definitions will be amended or clarified; the threshold for qualifying shareholdings in joint venture companies will be reduced from more than 30 per cent to 10 per cent or more.
DETAILS OF THE CLAUSE
2. Clause 46 provides for Schedule 10 to have effect.
DETAILS OF THE SCHEDULE
3. Paragraph 1 provides for Schedule A1 to the Taxation of Chargeable Gains Act 1992 (TCGA) to be amended as set out in paragraphs 2 to 12 of the Schedule.
Revenue Protection Provisions
4. Paragraph 2 repeals the provision (paragraph 11 Schedule A1 TCGA) under which a relevant change of activity by a close company leads to the loss of accrued taper relief on the shares in that company.
5. Paragraph 3(1) inserts paragraph 11A into Schedule A1 TCGA.
Paragraph 11A of Schedule A1 TCGA
6. Sub-paragraph (1) provides that any period after 5 April 1998 is not to count for taper relief on shares of that company during which the company is a close company and is not ?active?.
7. Sub-paragraphs (2) - (5) define what is meant by ?active?. Any company that is carrying on a business, preparing to carry on a business, or winding up a business will be treated as active.
8. For paragraph 11A purposes, a company is treated as carrying on a business even if the business is not being conducted on a commercial basis and with a view to profit. The activity of holding and managing assets will be treated as the carrying on of a business.
9. Active companies will include holding companies of groups provided that at least one group member is active. A company is also active if it holds a qualifying shareholding in a joint venture company.
10. A company will not be treated as active if its activities consist only of holding assets of insignificant value (in aggregate), holding money, holding shares or debentures of a company that is not active, making loans to associated companies or participators, or fulfilling statutory requirements such as Companies Act registration.
11. Sub-paragraphs (6) and (7) provide supplementary definitions.
12. Paragraph 3(2) of the Schedule provides that paragraph 11A has effect in relation to disposals on or after 17 April 2002.
Definitions: Holding Company &c
13. Paragraph 4 broadens the meaning of holding company for taper relief purposes. A ?holding company? will be a company that has one or more 51 per cent subsidiaries; in assessing whether a company is a holding company, all other activities of the holding company will be ignored.
14. Consequential changes are made to the provision dealing with qualifying shareholdings in joint venture companies (paragraph 23 Schedule A1).
15. These changes apply to disposals on or after 17 April 2002 and in relation to periods of ownership on or after that date.
16. Paragraph 5 introduces the meaning of ?interest in shares? as an interest as a co-owner of shares, and ?interest in debentures? as an interest as a co-owner of debentures. These definitions apply to disposals on or after 17 April 2002 and in relation to periods of ownership on or after that date.
17. Paragraph 6 inserts a reference to ?joint venture company? (JVC) and ?qualifying shareholding? in relation to JVCs into the list of definitions in paragraph 22 Schedule A1. (The definition of a JVC is amended by paragraph 11 of Schedule 10.) Consequential changes are made to paragraph 23 Schedule A1 (the provision dealing with JVCs). The changes made by paragraph 6 apply in relation to disposals on or after 17 April 2002.
18. Paragraph 7 moves the existing definition of ?ordinary share capital? which appears in two places in Schedule A1 to paragraph 22 of Schedule A1, which contains definitions that apply throughout the Schedule. This is effective for disposals on or after 17 April 2002.
Treatment of Certain Debentures
19. Paragraph 8(1) provides that certain debentures received in exchange for shares or other debentures on company reorganisations, reconstructions &c count as shares for taper relief purposes. It applies to debentures that are deemed to be securities for certain CGT purposes (under section 251(6) TCGA). (Actual securities are already treated as 'shares? for taper relief purposes.) This means that these deemed securities may therefore qualify for business assets taper relief under the rules for shares, subject to the other conditions being met.
20. Paragraph 8(2) ensures that the new treatment applies generally to disposals from 6 April 2001 and applies for prior holding periods. So if a debenture (that is not a qualifying corporate bond) is deemed to be a share under this paragraph, is treated as acquired before 6 April 1998, and has always met the other rules for a share to be a business asset, a disposal on say 6 April 2001 would qualify for three years of business asset taper relief.
21. Paragraph 8(3) defers the implementation of the new definition as regards certain revenue protection measures so that these measures are not affected by this new treatment of debentures for times or events before 17 April 2002.
22. Paragraph 8(4) similarly disapplies the new definition for debentures issued before 17 April 2002 on, for example, building society demutualisations.
Definitions: Trading Company &c
23. Paragraph 9 inserts a new paragraph into Schedule A1 to clarify the definition of ?trading company?, but is not intended to alter the substance of the existing definition.
Paragraph 22A of Schedule A1 TCGA
24. Paragraph 22A defines a ?trading company? as a company carrying on ?trading activities? whose activities do not to any substantial extent include activities that are not trading activities.
25. ?Trading activities? include, for this purpose, activities carried on by the company preparatory to carrying on a trade or with a view to its acquiring a trade or starting to trade. They also include the acquisition of an interest in a company that becomes a trading subsidiary (or the holding company of a trading group), or the acquisition of a qualifying interest in a joint venture company. The acquisition of the trade or starting to trade must be made as soon as is reasonably practicable in the circumstances.
26. The changes made by paragraph 22A apply to disposals on or after 17 April 2002 and in relation to periods of ownership on or after that date.
27. Paragraph 10 inserts a new paragraph into Schedule A1 to clarify the definition of ?trading group?, but is not intended to alter the substance of the existing definition.
Paragraph 22B of Schedule A1 TCGA
28. Paragraph 22B defines a ?trading group? 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.
29. ?Trading activities? include, for this purpose, activities carried on by any member of the group preparatory to carrying on a trade or with a view to its acquiring a trade or starting to trade. It also includes the acquisition of an interest in a company that becomes a trading subsidiary (or the holding company of a trading group) or the acquisition of a qualifying interest in a joint venture company. The acquisition of the trade or starting to trade must be made as soon as is reasonably practicable in the circumstances.
30. The changes made by paragraph 22B apply to disposals on or after 17 April 2002 and in relation to periods of ownership on or after that date.
31. Paragraph 11 revises the meaning of ?joint venture company? (in paragraph 23 Schedule A1 TCGA) to include qualifying shareholdings by persons who are not companies. A ?joint venture company? will be a trading company or the holding company of a trading group where there are five or fewer persons who between them hold 75 per cent or more of its ordinary share capital.
32. This paragraph also reduces the threshold for a shareholding in a joint venture company to be a ?qualifying shareholding?. A ?qualifying shareholding? will be a holding that provides 10 per cent or more of the ordinary share capital (the present threshold is more than 30 per cent).
33. A new provision concerning a holding company that is a joint venture company is introduced so as to treat such a holding company and its 51 per cent subsidiaries as carrying on a single business, and disregarding intra-group activities.
34. These changes apply to disposals on or after 17 April 2002 and in relation to periods of ownership on or after that date.
35. Paragraph 12 revises the meaning of ?joint enterprise company? to include qualifying shareholdings by persons who are not companies. A ?joint enterprise company? will be a trading company or the holding company of a trading group where there are five or fewer persons who between them hold 75 per cent or more of its ordinary share capital. This paragraph also reduces the threshold for a shareholding in a joint enterprise company to be a ?qualifying shareholding?. A ?qualifying shareholding? will be a holding of 10 per cent or more of the ordinary share capital (the present threshold is more than 30 per cent).
36. This change applies to disposals on or after 17 April 2002 and in relation to periods of ownership on or after that date.
BACKGROUND NOTE
CGT Taper Relief: General
37. CGT taper relief was introduced in the Finance Act 1998. The relief progressively reduces the amount of a gain that is chargeable to CGT on the disposal of an asset, the longer that asset is held after 5 April 1998. Taper relief applies to the capital gains of individuals, trusts and the personal representatives of deceased persons, but not to the chargeable gains of companies.
38. A more generous taper rate applies to business assets than to non?business assets. Business assets include:
- assets used in an individual's own trade, and
- certain shareholdings in trading companies.
Revenue Protection Provisions
39. Relevant change of activity. Paragraph 11 of Schedule A1 TCGA provides that, on a the disposal of shares in a close company, taper relief is restricted if the company has since 6 April 1998:
- started to trade; or
- started, or significantly increased the size of, a business of holding investments.
40. Paragraph 11 was designed to tackle the problem of ?enveloping? assets, where a person obtains additional taper relief by arranging that an asset which has been held for a short time is held by a company the shares in which have been held longer than the asset in question. The disposal of the asset is effected by disposing of the shares with the consequence of a greater amount of taper relief.
41. Enveloping is less of an issue than it was when taper relief was introduced, in part due to the reduction in the qualifying holding period for business assets.
42. Inactive companies. The new provisions mean that times when a company is inactive do not count for taper relief purposes. That will provide protection against transactions seeking excessive taper relief. For example, an individual could set up a company in year 1; do nothing with it for several years; in year 8 use it to acquire an asset; and in year 10 sell the company. Without this protection, the individual could - in effect - obtain ten years of taper relief on the gain on an asset held for only two years.
43. The new measure will also ensure that people are not accidentally disadvantaged if they use a long-held dormant company to start up a trade. Without the existing paragraph 11 of Schedule A1 and with no replacement, they would find that part of a gain on disposal was a gain on a non-business asset and part on a business asset, leading to less taper relief than expected, even though the company was doing nothing and not actively pursuing a non-trading business.
44. Because the new provision relates to the company in which shares were held at any time, the effects will be more easily predictable, especially in cases where a company is reconstructed. A person might hold shares in company A and exchange them for shares in company B in circumstances where the CGT rules provided for the share exchange not to be treated as a disposal. The assessment of whether the shares were shares in an active company would be made in relation to the company in which shares were actually held at the time, that is initially company A, after the date of the exchange company B. The provision will therefore work in the same way as the assessment of entitlement to business assets taper relief in share exchange cases.
Deemed Securities
45. An exchange of one asset for another is a disposal for CGT purposes and tax may be due. However, certain company reorganisations and reconstructions, where shares or debentures are exchanged, or treated as exchanged, for other shares or debentures, are treated as not involving any immediate disposal. Instead, any gain is taxed on a subsequent disposal of the new holding of shares or debentures.
46. Business assets taper relief may be available on a security. Not all debentures issued by companies are securities. So that the special rules deferring gains described in paragraph 45 above operate properly section 251(6) TCGA provides that any debentures issued in company reorganisations, reconstructions &c are deemed to be securities. This treatment did not previously extend to the rules governing taper relief and company debentures issued in this way that were not securities would not, in practice, qualify for business assets taper relief.
47. The change in this measure will extend the scope of business assets taper relief so that it may also be available on a debenture that is deemed to be a security. As well as extending business assets taper relief to more assets the change will reduce compliance costs, as people will not need to concern themselves as to whether their debentures are securities.
48. Certain taper relief revenue protection measures, which apply to shares and securities but not to other assets, will now also apply to these deemed securities. The implementation has been phased so that no one is disadvantaged for any transactions that have happened (for example, a relevant shift in value) prior to the announcement of the detail of the changes on 17 April 2002.
Definitions for Taper Relief
49. Business assets taper relief is available on certain shares in trading companies and holding companies of trading groups.
50. Holding company. The existing definition excludes certain companies from being holding companies if they conduct a substantial amount of non-trading activity, other than holding shares in subsidiaries (the existing legislation already ignores trading activity in deciding whether a company is a holding company). The new provision means that any company with 51% subsidiaries will be a holding company irrespective of its other activities.
51. This leaves a group of companies free to organise itself how it wishes - for example, holding group properties could be by the holding company or by a property investment subsidiary. The change reduces any adverse impact that the CGT rules might have on company structure and means that more shares will qualify for business assets taper relief.
52. Trading company/Trading group. The wording of the existing definition is based on the purposes of a company. The Inland Revenue has made clear that it would infer the purposes from the actual activities that the company enters into. Inland Revenue guidance had also made clear that intra-group activities would be ignored. The change in the wording therefore aligns the statute with existing practice.
53. Joint venture company. Investment in other companies normally makes it less likely that a company is a trading company (the holding of the shares is treated as an investment activity), so that it is more difficult for its shares to qualify for business assts taper relief. Qualifying holdings in JVCs do not have that effect. The broadening of the definition of a JVC and the reduction in the minimum size of a qualifying holding will increase the number of companies treated as trading companies for taper relief.
54. Joint Enterprise Company (JEC). Employees can obtain business assets taper relief on shares in the company for which they work or one that has a relevant connection with it. JECs provide for relevant connections where JVCs are involved. The definitions are being aligned with those for JVCs. As a result, more employees will qualify for business assets taper relief.
55. Interest in shares. For entitlement to business assets taper relief, different rules apply to shares (including securities) and interests in shares as opposed to other assets.
56. The definitions of ?trading company?, ?trading group?, ?joint venture company? and ?interest in shares? are in line with those used in the new exemption for gains and losses on disposals by companies of substantial shareholdings - see clause 43 and Schedule 8 of this Bill.