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FA 2011 analysis: Chargeable gains and value shifting

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The lengthy consultation on the taxation of chargeable gains on companies has culminated in changes to the rules on value shifting, on capital losses on changes of ownership, and on degrouping (FA 2011 ss 44–46, Schs 9–11). While the rules on value shifting and capital losses are generally simpler, the opportunity to have a single set of rules covering each of value shifting and capital losses on changes of ownership has been missed. The amended degrouping charge is simpler to operate, despite longer legislation, and will benefit many companies. But it introduces a major mismatch between the rules for tangible assets and those for intangible assets

The changes in Finance Act 2011 Schs 9, 10 and 11 cover the value shifting rules, the degrouping charge and the rules for capital losses on change of ownership.

The changes to the degrouping charge are those which will probably affect most companies, so this will be the focus of the majority of the article.

But let us start off by briefly reviewing the changes in the other two areas and the practical implications.

Value shifting

The old value shifting rules, at TCGA 1992 ss 31-34 were narrowly targeted at specific tax avoidance schemes whereby a company would reduce the value of shares or securities that it was selling, usually by extracting all the value as an artificially enhanced dividend, which was not taxable, prior to the sale, so that the gain on disposal was small.

The new rule which replaces TCGA 1992 ss 31–34 is a widely drawn, motive-based test

The value shifting rules permitted HMRC to adjust the consideration for the transaction by an amount that was ‘just and reasonable’ in order to bring the full gain into charge.

The rules were complex but mechanical and prescriptive, so there was little room for uncertainty as to their application. And, since they were targeted at specific avoidance schemes, it was unlikely that taxpayers would fall within the rules by accident (although I have seen it happen).

The new rule, which replaces TCGA 1992 ss 31–34 is a widely drawn, motive-based test. It applies if there are arrangements whereby the value of the shares or securities, or of an underlying asset, is materially reduced with a main purpose of obtaining a tax advantage, unless the arrangements consist solely of making an exempt distribution (so that paying a normal pre-sale distribution is not caught by the new rule).

It is important to remember that the value shifting rules will not apply to disposals to which the substantial shareholdings exemption applies, so in many cases the new rule will not need to be considered.

The simplified rule will increase uncertainty, as there is no prescription of relevant transactions. Prior to any disposal of shares or securities by a company, the vendor will need to carry out extensive due diligence on past transactions (there is no time limit to this legislation) that might have had an impact on the value of those shares or securities, and to ensure that they have documentary evidence available to demonstrate that there was no intention to obtain a tax advantage.

In practical terms, this is going to create more difficulty for commercial group rearrangements and will increase the record-keeping required

The availability of evidence as to the motives for transactions carried out before FA 2011 may be a problem, as they clearly did not fall within the old rules, so there would have been no reason to keep evidence relating to motive.

On another level, however, planning that was used to get around the old ss 31 and 32 should still work. Typically, instead of a vendor selling the value-shifted shares, a purchaser would subscribe for new shares in the target company such that it would hold the vast majority of the shares. If there was no disposal by the vendor, there was no consideration to adjust.

A time limit has been imposed on the depreciatory transactions legislation at TCGA 1992 s 176 so that allowable losses are only adjusted in respect of depreciatory transactions within the six years prior to the disposal.

However, there is still no such time limit for value shifting, so there is no practical impact on, for example, the need for pre-disposal due diligence.

Capital losses on change of ownership

The main changes here relate to TCGA 1992 Sch 7A and the definition of ‘pre-entry losses’. Previously, pre-entry losses included both actual losses of a company joining a group and the pre-entry proportion of losses arising on the disposal of assets held by the company when it joined the group.

The legislation relating to the pre-entry proportion of a loss was fairly complex, so its repeal by FA 2011 is a simplification but not of great practical significance, as capital loss-buying has largely ceased due to the anti-avoidance rules at both TCGA 1992 s 184A and Sch 7A.

There is also a relaxation of the rules relating to the way in which a pre-entry loss can be used. If the target company was carrying on a trade when it was acquired and a gain arose on an asset used in that trade, even after the acquisition, a pre-entry loss of that company could be used to shelter any gains accruing on the disposal of that trading asset, so long as the company continued to carry on the trade.

Under the new rules, the pre-entry loss can be used against a gain accruing on the disposal of an asset used in any business of the company, which is much wider than a trade. And the pre-entry loss can be used in this way even if the business has been transferred to another company in the group.

Once again, this relaxation of the rules is unlikely to be of wide significance.

Degrouping charges

The headlines changes to the charge are:

  • where there is a disposal of shares, the degrouping charge will accrue to the vendor company or companies;
  • the substantial shareholdings exemption is enhanced to permit the packaging of trading activities into new companies;
  • the associated company exception from the degrouping charge has been tightened up; and
  • there is a provision to apply for a just and reasonable reduction in the degrouping charge to prevent double taxation.

Each of these will have their own practical consequences.

Degrouping charge falls on the vendor

A degrouping charge arises where a company leaves a group holding an asset transferred to it by another group member within the last six years.

The target company is treated as having disposed of the asset and immediately reacquired it at the market value at the date of the intra-group transfer.

Under the new rules, where the degrouping results from a disposal of shares (the ‘group disposal’) the chargeable gain on the deemed disposal is added to the consideration for the disposal so that the charge will fall on the vendor company.

(Where the degrouping doesn’t arise from a disposal of shares, the charge continues to accrue to the company leaving the group.)

The practical impact is that any reliefs or exemptions from tax that might apply to the group disposal will also apply to the degrouping element of the consideration.

Not all of the legislation is shorter or less complex but much of it should now be simpler to apply in practice

For example, if the substantial shareholdings exemption applies to the disposal of shares, it will also apply to exempt the degrouping element of the gain. Similarly, if the degrouping arises as a result of the transaction to which s 127 applies (reorganisations or share-for-share exchanges and reconstructions), the new degrouping rule applies to ensure that no charge arises at the time of this deemed reorganisation.

However, in these cases, if there is a subsequent disposal of the shares or securities acquired by the vendor, the degrouping element comes back into charge as a deemed increase in the consideration on that disposal of the new holding. Unless, of course, the disposal of the new holding is, itself, exempt.

The practical impact is that it will make transactions and transaction documentation much simpler. There will no longer be a requirement for the sale and purchase agreement to refer to elections under s 179A, to elect the degrouping gain onto the vendor, or for disclosures against warranties in respect of potential degrouping charges.

The downside is that these rules only apply to chargeable assets to which the capital gains legislation applies and there is no similar change in respect of the degrouping charge relating to intangible fixed assets. This is extremely unfortunate and leaves a mismatch between the rules for chargeable assets and those for chargeable intangible assets.

Extension to substantial shareholding exemption

While a trading group selling a trading subsidiary was able to take advantage of the substantial shareholdings exemption, there was no equivalent for a disposal of a trade out of a company.

We now have a facility to ‘package’ trading activities into a new company prior to sale in such a way that no degrouping charge will arise and the disposal will qualify for the substantial shareholdings exemption.

The new legislation, at TCGA Sch 7AC para 15A, allows a group to create a new subsidiary and transfer trading activities and assets into that company.

As long as the assets were being used for at least a year before the transfer for the purposes of a trade carried on by another member of a group, and after the transfer are used by the new company for the purposes of a trade that it is carrying on, the vendor is treated as having held the substantial shareholding for the required 12 months.

Paragraph 19 is amended to ensure that the new company is also treated as having been a trading company for the same 12-month period.

As a result, a disposal of the new company holding the trade transferred to it should qualify for the substantial shareholdings exemption and, by the operation of the new degrouping rules in TCGA 1992 s 179 the degrouping element should be exempt.

In practical terms this is an extremely useful change and will facilitate trade sales in a way that was not previously possible due to artificial tax barriers.

Again, however, it is unfortunate that these changes do not apply to the degrouping charge in respect of intangible fixed assets.

This means that, in practice, the new facility will be next to useless for companies which started trading on or after 1 April 2002 and have substantial goodwill, or which otherwise have a large amount of their value in the form of intangible assets.

The associated companies rule

In the Johnston Publishing case [2008] STC 3116, the Court of Appeal determined that the associated companies exception to the degrouping charge only applied where the companies were associated both at the time of the intra-group transfer and when they left the group together.

HMRC have now taken the opportunity to ‘clarify’ the position. The exception will now apply if both the transferor and transferee company are 75% and effective 51% subsidiaries of another company at the date of the intra-group transfer and remain so until immediately after they case to be members of the group together, or if one is a 75% and effective 51% subsidiary of the other and remains so until immediately after they cease to be members of the group together.

What this means is that once an intra-group transfer has happened between group companies, the relationship between them must remain in place until any subsequent disposal, or until the six-year period has expired, if the exception is to apply when the companies leave the group together.

In practical terms, this is going to create more difficulty for commercial group rearrangements and will increase the record-keeping required, too.

Given that degrouping charges would be a matter for self-assessment, this change could also provide HMRC with ammunition to charge penalties if any degrouping charges are missed as a result of these new rules.

Just and reasonable adjustments

The issue of double taxation has always been a problem with the degrouping charge, but the new TCGA 1992 s 179ZA should help to alleviate the problem.

Essentially, this provision allows a company on which a degrouping charge arises to claim to have that charge reduced by an amount that is just and reasonable, having regard to any transaction whereby the relevant company acquired the asset to which the gain relates. So where there is double taxation, HMRC are required to reduce or eliminate the degrouping element of any gain.

As a quid pro quo, the base cost of the asset that has been deemed to have been sold and immediately reacquired is also reduced by the same amount, to avoid double relief, too.

This new rule should facilitate transactions which might otherwise have faltered on the basis of an excessive tax charge.

However, there is no facility to make the claim prior to the transaction, so there is still an element of risk and uncertainty, in that HMRC might disagree with the proposed adjustment. Nevertheless, the change is very much welcomed.

Other changes

There are some minor changes to note:

  • Where a gain arises in a company that is degrouped (where there was no share disposal) the gain may be treated as accruing to another group company under TCGA 1992 s 171A as amended (s 179A has been repealed).
  • Section 179B, permitting a rollover of the degrouping gain, has also been repealed, so that degrouping gains can no longer be rolled over into the acquisition of new business assets.
  • TCGA 1992 s 139 treats a transfer of a company’s business to another company as part of a scheme of reconstruction as occurring at no gain and no loss, so long as there is no consideration for the transfer. So a degrouping element which would otherwise be added to the consideration for the transaction is ignored for the purposes of s 139. HMRC has said in correspondance that the degrouping element falls out of charge completely in such a case.


The new rules apply in respect of companies leaving groups on or after the date of Royal Assent. However, the principal company of a group may make an election that the new rules apply from 1 April 2011, which is helpful if a disposal to which a degrouping charge would apply is being made before Royal Assent.

The election must be made by 31 March 2012. It can also be revoked on or before that date, with the consent of any company leaving the group that would thereby suffer a degrouping charge.

Simpler to apply in practice

The new legislation follows extensive consultation. Not all of the legislation is shorter or less complex but much of it should now be simpler to apply in practice.

In particular, the degrouping rules are substantially simplified in their operation and will make a material difference to the ability of groups to buy and sell trades. I believe that this form of simplification is much more important than merely abbreviating the legislation.

Pete Miller, Partner, The Miller Partnership