Changes are proposed to the chargeable gains rules which affect how the degrouping charge arises on a share sale. The scope of the substantial shareholding exemption is to be widened and the associated companies relief from degrouping charges clarified. The pre-entry loss rules are to be simplified and some complicated value shifting provisions are to be replaced with a TAAR. This basket of changes should on the whole make the chargeable gains treatment of M&A transactions more straightforward, although there are areas of additional complexity, and some less taxpayer-friendly changes to watch out for.
Various changes are proposed for the corporation tax on chargeable gains rules under the ‘simplification’ banner, although it is not clear that all these changes amount to simplification!
Degrouping charges
The most important change is that, where the degrouping charge arises due to the sale of shares by a company subject to UK corporation tax, the degrouping charge will be treated as an adjustment to the seller’s gains/losses on the disposal of shares rather than arising in the company leaving the group.
This has the knock-on effect that, if the disposal qualifies for the substantial shareholding exemption (SSE) (or would have done had it been a taxable transaction), so will any degrouping gain/loss.
If there is more than one relevant share disposal, the parties may elect to allocate the gains/losses as they see fit.
A further change is required to ensure that reconstruction relief under TCGA 1992 s 139 (which requires that the seller receives no part of the consideration for a disposal) is not denied due to the additional consideration deemed to be received under the new s 179 mechanism.
The old method of assessing the degrouping charge continues to apply in other situations, including where the company leaves the group otherwise than as a result of the disposal of shares.
It is interesting to note that the Exchequer expects to receive £10m more tax each year as a result of this change, possibly due to the reduction in tax losses. In the past it might have been possible to crystallise losses under s 179 whilst making SSE exempt gains elsewhere.
The drafting of the ‘backstop’ provision in s 179ZA, which will allow a just and reasonable adjustment of the s 179 charge, is opaque, but is apparently intended to avoid double charges, and also to apply where the associated companies relief is not available because the transferee has been liquidated. HMRC guidance on this will hopefully make its practical application clearer.
Moreover, some true simplification! The whole of s 179A is to be repealed and instead in future a s 179 degrouping gain or loss may be transferred around a group by making an election under s 171A.
Associated companies relief
Changes are made to bring the associated companies relief in s 179(2) more clearly in line with HMRC’s interpretation of the legislation (which was admittedly to some extent supported by the Court of Appeal in Johnston Publishing (North) Ltd v HMRC [2008] EWCA Civ 858). The changes make it clear that for the relief to apply the transferor and the transferee must form a subgroup for the period from the date of the original asset transfer to just after the two companies leave the group, and this is either because either the transferor or the transferee is the principal company of the subgroup or (and this is an extension) because a third company is a principal company of the sub-group. It should be noted that it is not possible to satisfy one condition for part of the relevant period and the other condition for the remainder of the period.
Group transfer
The final change to s 179 is simplification. It is to be made clear that s 179 only applies in the situation where both the transferor and the transferee were in the same group at the time of the transfer of the relevant asset.
Previously, it was technically possible for the provision to apply where only the transferor was a member of the group at the time of the original transfer (the transferee joining the group subsequently, only then to leave the group as so to cause s 179 to apply).
SSE conditions
Where a single company carries on more than one business, it might need to hive a business into a separate company in preparation for sale. Previously, the sale of the shares in the new company would not have qualified for SSE (because neither the investing company nor the trading company requirement would have been met) and a degrouping charge would have arisen in respect of the hive-down.
A proposed change will, however, allow SSE to apply in this situation so long as the assets have been used in the trade of another member of the group for a 12-month period prior to the transfer to the new company.
Groups that carry on their trades on a divisionalised basis will therefore no longer be prevented from relying on SSE, so long as a hive down is acceptable to the purchaser, although at this stage it does not appear that the same change is proposed for the equivalent intangible degrouping charge in CTA 2009 Part 8 for intangibles acquired since 2002.
Pre-entry losses
Since they were originally introduced in 1993, most tax advisers have generally approached advising on the pre-entry loss rules in TCGA 1992 Sch 7A with a heavy heart.
Whilst the principle underlying them is reasonably well understood – since 2005 they have applied to realised and unrealised losses that accrued in a company before it joined the group – the legislation is long and complicated.
In addition, since the CGT TAARs were introduced in December 2005, it has been less obvious that HMRC needed the additional protection of Sch 7A.
The good news is that Sch 7A is to be simplified, although sadly it is not to be repealed in its entirety.
In relation to losses that are realised by a ‘loss company’ before it joins the group, one first needs to consider the TAAR in TCGA 1992 s 184A, which applies to prevent the loss being used where there is a tax advantage purpose.
If there is no such tax advantage purpose, what remains of Sch 7A will now restrict the use of the loss to gains on assets:
Sch 7A will cease to apply to latent losses that are not realised until after the company joins the group, so the loss is available unless s 184A applies (because there is a tax advantage purpose).
Value shifting
Another difficult area in the chargeable gains code is value shifting.
In particular, the complicated provisions which apply on the disposal of shares or securities contain many traps for the unwary.
It is therefore not surprising that these provisions were considered ripe for simplification.
TCGA 1992 ss 31–34 are therefore to be repealed, and replaced with a much shorter TAAR that will apply only where the purpose of any arrangements that have reduced the value of shares or securities was to obtain a tax advantage (the definition of which is drafted so as only to target the avoidance of a liability to corporation tax on chargeable gains).
Where it applies, the rule will provide for the consideration received on a disposal to be adjusted by an amount that is just and reasonable in light of the value reducing arrangements.
The new rule does not contain a time limit, although in practice most situations caught by the new s 31 will involve steps taken at the time when the subsequent disposal was already in contemplation.
The new TAAR is not intended to apply to simple pre-sale dividends, because of the carve-out for the situation where the arrangements ‘consist solely of the making of an exempt distribution’, the definition of exempt distribution referring back to the final ‘mop-up’ exempt class in CTA 2009 Part 9A.
It is hoped that the promised guidance will make it clear that, for example, any funding of the dividend payment would not fall foul of the ‘solely’ requirement.
Is this good news? It is certainly simpler drafting, which is to be welcomed, but there must be concerns that the broader TAAR approach may in some cases cause increased uncertainty particularly in the absence of a clearance regime.
The new s 31(5) is another opaque piece of legislation, but is intended to deal with arrangements to reduce the value of a company without an actual disposal of shares (perhaps by using a ‘swamping’ issue of shares).
A small but welcome change in this area is the introduction of a six-year time limit in TCGA 1992 s 176, which should make it easier to ascertain whether any capital loss needs to be adjusted for prior depreciatory transactions.
Conclusion
This basket of changes should on the whole make the CGT treatment of mergers and aquisitions transactions more straightforward, although there are areas of additional complexity, and some less taxpayer-friendly changes to watch out for.
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Sara Luder, Partner, Slaughter and May
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