My client is a shareholder in a company that refurbishes and sells on property. The company has just sold its last major property and the other two shareholders are looking to exit. How do you recommend that we proceed, given that my client is keen to see what other post-Brexit property opportunities the market may present?
Answer
The first option to consider is a share buy-back. There have been a number of excellent articles recently setting out the tax and legal requirements of such a transaction and readers are referred to the 4 March 2016 edition of this journal for further details.
The key issue for these purposes though is that CTA 2010 s 1033 allows the proceeds of such a buy-back to be treated as capital in certain circumstances, in particular when the transaction is being carried out for the benefit of the trade and the shares have been held for at least five years.
However, one point that is often overlooked is that CTA 2010 s 1048 excludes certain trades from benefiting from the capital treatment. A trade for these purposes does not include dealing in shares, securities, land or futures. Although HMRC’s manuals are silent on what is meant by property dealing in the context of these provisions, Venture Capital Schemes Manual VCM3020 sets out that ‘dealing in land’ includes cases where steps are taken, before selling the land, to make it more attractive to the purchaser. This includes the refurbishment of existing buildings.
Therefore, in this case, we would not expect our two exiting shareholders to benefit from capital treatment on a share buy-back. Instead, they will potentially be taxed at dividend rates of up to 38.1% on the amounts they receive in excess of the repayment of capital on their shares.
Further care is needed if the exiting shareholders did not subscribe for their shares but bought them at a premium from a previous shareholder. In such circumstances, even if the shares are disposed of for no overall profit, the shareholders will still be deemed to receive dividend income on the difference between their respective proceeds and the original capital paid on the shares on subscription under CTA 2010 s 1000(1)(B). If an equal and opposite capital loss should arise, ITA 2007 s 131 relief against general income will not be available as, once again, the company undertakes an excluded trade. This can create the inequitable position of giving rise to an income tax liability despite the shareholders making no profit on the share buyback.
For all of these reasons, the share buy-back route is inappropriate. We therefore need to consider alternatives.
Holding company structure
Another possibility is to insert a holding company above ‘PropCo’ Limited. The exiting shareholders can be paid out in cash, funded from dividends paid up from the latter (assuming, of course, sufficient reserves are available).
Meanwhile, your client can receive shares in HoldCo by way of consideration. We may also look to hive up the remaining trade of PropCo into the new holding company in due course. Not only will this reduce compliance costs going forward but it should protect the remaining shareholder from any unforeseen claims subsequently arising against the old business. Such a business transfer should not attract any tax charges: it should be a TOGC for VAT purposes and both CGT and SDLT group relief should be in point (with specific protection from exit charges applying on the winding up of the sole subsidiary of the group under TCGA 1992 s 179(1) and FA 2003 Sch 7 para 4(4) respectively).
On such a share for share exchange, it is normal to seek clearance under TCGA 1992 s 138 and ITA 2007 s 701 that this reorganisation can be undertaken free of CGT and will not fall foul of the transaction in securities rules.
Somewhat surprisingly, we have had recent experience of similar applications being questioned by HMRC. In particular, it has suggested that it would instead be more appropriate to liquidate PropCo! Such an approach is of course highly likely to fall foul of the new targeted anti-avoidance rule (TAAR) at ITTOIA 2005 s 396B.
Phoenix company arrangements have always potentially been subject to counteraction under the transaction in securities rules (see IRC v Joiner [1975] 1 WLR 1701); however, the TAAR extends HMRC’s reach to the liquidation proceeds receivable by an individual on the winding up a close company where that individual carries on the same or a ‘similar’ trade in broadly any capacity within the following two years. A safe harbour is only provided where the winding up does not have a tax avoidance motive.
As well documented, there is no advance clearance mechanism under the TAAR. Furthermore, it is worth noting that HMRC is now (a little menacingly) placing caveats on any clearances granted under ITA 2007 s 701 in respect of liquidations, to the effect that such assurances do not provide any guarantee that the TAAR will not be in point.
This remains unsatisfactory and we only have the limited examples in TaxGuide 02/16 (a note of the meeting with HMRC on 26 January 2016 published by the ICAEW Tax Faculty) for assistance as to how HMRC will seek to apply this new provision in practice. We are assured though that it is working on guidance which will be published ‘in due course’!
Turning back to our example above, we have been successful in ultimately obtaining the required clearances for the insertion of a new holding company in these circumstances. It is somewhat troubling though that HMRC seems to imply that however we now proceed, there is a suggestion of tax avoidance at hand.
Setting aside the above concern, on inserting HoldCo, the only tax charge on this reorganisation should accordingly be a stamp duty charge. Strictly, this is payable at a rate of 0.5% not on the value of the shares in PropCo so acquired but on the value of the consideration shares issued by HoldCo. It has been suggested that if the number of consideration shares issued by HoldCo is ‘swamped’ by the number of founder shares already in existence, this accordingly reduces the value of consideration on which stamp duty is payable. Such planning, although relatively widespread, should be implemented with caution.
Finally, by stripping out the remaining profits of PropCo by way of dividends up to HoldCo, it should be possible to then wind up the former on a tax free basis.
In summary, the HoldCo route should allow the exiting shareholders to benefit from capital treatment and a possible CGT rate of 10% under entrepreneurs’ relief. Meanwhile, your client is free to pursue new business ventures via a clean company.
My client is a shareholder in a company that refurbishes and sells on property. The company has just sold its last major property and the other two shareholders are looking to exit. How do you recommend that we proceed, given that my client is keen to see what other post-Brexit property opportunities the market may present?
Answer
The first option to consider is a share buy-back. There have been a number of excellent articles recently setting out the tax and legal requirements of such a transaction and readers are referred to the 4 March 2016 edition of this journal for further details.
The key issue for these purposes though is that CTA 2010 s 1033 allows the proceeds of such a buy-back to be treated as capital in certain circumstances, in particular when the transaction is being carried out for the benefit of the trade and the shares have been held for at least five years.
However, one point that is often overlooked is that CTA 2010 s 1048 excludes certain trades from benefiting from the capital treatment. A trade for these purposes does not include dealing in shares, securities, land or futures. Although HMRC’s manuals are silent on what is meant by property dealing in the context of these provisions, Venture Capital Schemes Manual VCM3020 sets out that ‘dealing in land’ includes cases where steps are taken, before selling the land, to make it more attractive to the purchaser. This includes the refurbishment of existing buildings.
Therefore, in this case, we would not expect our two exiting shareholders to benefit from capital treatment on a share buy-back. Instead, they will potentially be taxed at dividend rates of up to 38.1% on the amounts they receive in excess of the repayment of capital on their shares.
Further care is needed if the exiting shareholders did not subscribe for their shares but bought them at a premium from a previous shareholder. In such circumstances, even if the shares are disposed of for no overall profit, the shareholders will still be deemed to receive dividend income on the difference between their respective proceeds and the original capital paid on the shares on subscription under CTA 2010 s 1000(1)(B). If an equal and opposite capital loss should arise, ITA 2007 s 131 relief against general income will not be available as, once again, the company undertakes an excluded trade. This can create the inequitable position of giving rise to an income tax liability despite the shareholders making no profit on the share buyback.
For all of these reasons, the share buy-back route is inappropriate. We therefore need to consider alternatives.
Holding company structure
Another possibility is to insert a holding company above ‘PropCo’ Limited. The exiting shareholders can be paid out in cash, funded from dividends paid up from the latter (assuming, of course, sufficient reserves are available).
Meanwhile, your client can receive shares in HoldCo by way of consideration. We may also look to hive up the remaining trade of PropCo into the new holding company in due course. Not only will this reduce compliance costs going forward but it should protect the remaining shareholder from any unforeseen claims subsequently arising against the old business. Such a business transfer should not attract any tax charges: it should be a TOGC for VAT purposes and both CGT and SDLT group relief should be in point (with specific protection from exit charges applying on the winding up of the sole subsidiary of the group under TCGA 1992 s 179(1) and FA 2003 Sch 7 para 4(4) respectively).
On such a share for share exchange, it is normal to seek clearance under TCGA 1992 s 138 and ITA 2007 s 701 that this reorganisation can be undertaken free of CGT and will not fall foul of the transaction in securities rules.
Somewhat surprisingly, we have had recent experience of similar applications being questioned by HMRC. In particular, it has suggested that it would instead be more appropriate to liquidate PropCo! Such an approach is of course highly likely to fall foul of the new targeted anti-avoidance rule (TAAR) at ITTOIA 2005 s 396B.
Phoenix company arrangements have always potentially been subject to counteraction under the transaction in securities rules (see IRC v Joiner [1975] 1 WLR 1701); however, the TAAR extends HMRC’s reach to the liquidation proceeds receivable by an individual on the winding up a close company where that individual carries on the same or a ‘similar’ trade in broadly any capacity within the following two years. A safe harbour is only provided where the winding up does not have a tax avoidance motive.
As well documented, there is no advance clearance mechanism under the TAAR. Furthermore, it is worth noting that HMRC is now (a little menacingly) placing caveats on any clearances granted under ITA 2007 s 701 in respect of liquidations, to the effect that such assurances do not provide any guarantee that the TAAR will not be in point.
This remains unsatisfactory and we only have the limited examples in TaxGuide 02/16 (a note of the meeting with HMRC on 26 January 2016 published by the ICAEW Tax Faculty) for assistance as to how HMRC will seek to apply this new provision in practice. We are assured though that it is working on guidance which will be published ‘in due course’!
Turning back to our example above, we have been successful in ultimately obtaining the required clearances for the insertion of a new holding company in these circumstances. It is somewhat troubling though that HMRC seems to imply that however we now proceed, there is a suggestion of tax avoidance at hand.
Setting aside the above concern, on inserting HoldCo, the only tax charge on this reorganisation should accordingly be a stamp duty charge. Strictly, this is payable at a rate of 0.5% not on the value of the shares in PropCo so acquired but on the value of the consideration shares issued by HoldCo. It has been suggested that if the number of consideration shares issued by HoldCo is ‘swamped’ by the number of founder shares already in existence, this accordingly reduces the value of consideration on which stamp duty is payable. Such planning, although relatively widespread, should be implemented with caution.
Finally, by stripping out the remaining profits of PropCo by way of dividends up to HoldCo, it should be possible to then wind up the former on a tax free basis.
In summary, the HoldCo route should allow the exiting shareholders to benefit from capital treatment and a possible CGT rate of 10% under entrepreneurs’ relief. Meanwhile, your client is free to pursue new business ventures via a clean company.
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