Alan Pink considers whether different trades should be held in a group of companies or in stand-alone companies.
Where the same people are carrying on two or more different trades, for all kinds of reasons it’s often a good idea for those different trades to be carried on in different companies.
For example, it may be wished to ‘ring fence’ liabilities of one trade, so that they do not affect the others if anything goes wrong. Or perhaps you might want to put the different trades into different companies (rather than having them all in one company) so that the performance of the different trades can be more easily measured. Or perhaps you have a view to the possible separate sale of one of the trades in due course.
For whatever reason, I will be assuming in what follows that there are different companies carrying on different trades, but they are all in what is basically the same ownership.
Group or stand-alone?
The question I am looking to answer here is: should those companies form a group or be held as stand-alone? A group is broadly where one of the companies owns the others. The stand-alone situation, by contrast, is where the same shareholders directly own the shares in each of the companies.
I am going to look at the advantages and disadvantages of the group structure versus the stand-alone structure, and the impression these comparisons give will almost inevitably be to make the group structure seem like an easy winner in all situations (i.e. purely looking at the tax implications). But the stand-alone company structure has a trump card up its sleeve, so to speak, which I will come on to explain.
Group reliefs
To a large extent, it’s true to say that the tax system treats a group of companies as if they were effectively a single company. ‘Exhibit A’ of this tendency is the availability of group loss relief. Within a group as defined, trading losses made by one company in the group can be freely surrendered from the loss-making company to any other company within the group for offset against that other company’s profits.
Proponents of the stand-alone structure may point to the practical ability, in the real world, to ‘re-arrange’ the profit and loss position between connected companies. For example, one stand-alone company could make a management charge to the other, with a view to redressing the imbalance in profitability between the two. I have no doubt at all that this sort of method of what might be called ‘back door group relief’ in a collection of stand-alone companies is quite frequently resorted to in practice. But of course, it has difficulties, as HMRC is not slow to point out. The management charge from the loss-making company to the profitable company, for example, is not effective, properly, for tax purposes unless the company making the charge is genuinely providing services to the other, and the other cannot deduct the charge unless it is incurred wholly and exclusively for the purposes of its trade.
HMRC is very alive, on investigation, to the practice of ‘manipulating’ profits between connected companies.
Other group reliefs
Another tax benefit of having your companies in a group rather than having them stand-alone is that assets can be transferred between the companies without any capital gains arising. This is because, for transfers within a group, the deemed transfer value (whatever the actual consideration put on the transfer for accounting or legal purposes) is deemed to be such as gives rise to neither a gain nor a loss.
If the asset concerned is a property (in England or Northern Ireland), group relief is available against stamp duty land tax along very similar lines. And a group structure avoids another very nasty corporate taxation ‘trap’, as illustrated in the following example.
Example: Transfer of property between stand-alone companies
Mr X owns 100% of the shares in both A Ltd and B Ltd. He decides to transfer a building from one to the other at its original cost of £100,000. Its actual value is now £150,000, and Mr X accepts that A Ltd will be treated as making a gain by reference to this market value, such that A Ltd will end up with a taxable gain of £50,000.
What he does not reckon on, though, is that this undervalue for the purposes of the transfer will give rise to a deemed income distribution to him of £50,000. This is on the basis that A Ltd has lost this much value and enriched Mr X by increasing the value of B Ltd, due to the transfer between the two companies being at undervalue.
Group rollover relief
Yet another benefit of the group structure is that it is effectively treated as if it were a single entity for the purposes of capital gains rollover relief.
So if companies A and B are part of a group, and company A makes a gain on an asset used for the purposes of its trade, company B can secure rollover by acquiring a new asset for a similar consideration, for the purpose of its trade.
Asset holding companies
Asset protection is a major problem with the stand-alone company arrangement. It’s often wished to ‘ring-fence’ the valuable assets, particularly the HQ building, factory etc., by holding it in a separate company.
Do this in a stand-alone company, and you are forfeiting all the tax benefits that you should be getting from the fact that the property is used for the purposes of a closely-connected trade. The asset holding company will not be ‘relevant business property’ for inheritance tax relief purposes. A disposal of it will not qualify for capital gains tax (CGT) business asset disposal relief and the 10% rate, and any gain on the sale of the asset by the asset holding company cannot be rolled over against a new asset, even if it is acquired by the same company.
By contrast, if the asset holding company is a member of a group (typically the overall holding company of the group), all these reliefs are available.
‘Trump card’
So, in the face of all these tax drawbacks to the stand-alone situation, what is the trump card I referred to at the outset? This relates to the situation on ultimate sale.
Let’s go back to the case of A Ltd and B Ltd, both of which companies are owned by Mr X. If Mr X decides to sell A Ltd, he will personally pay CGT on any gain on the disposal. This tax will be at 20%, except to the extent that there is business asset disposal relief available, which would reduce the tax rate to 10%. But the point is that the funds, after this relatively acceptable level of CGT has been paid, are then freely available for Mr X to spend however he wishes, including on private expenditure.
If, instead of owning A Ltd and B Ltd directly, Mr X had been the shareholder of a holding company, H Ltd, which in turn owned 100% of the shares of each of A Ltd and B Ltd, a sale of A Ltd would result in the proceeds going into H, rather than into Mr X’s personal bank account. Interestingly, it is likely, if the conditions for the ‘substantial shareholdings exemption’ are met, that H Ltd would have no tax to pay on the gain from selling its subsidiary. This looks like yet another knock-out blow in favour of the group structure.
But the problem is, if the individual shareholder then wants to extract the proceeds, he will normally have to do so by way of paying a dividend, with a likely charge to tax at 32.5% or 38.1%. So at the end of the day, it would be much cheaper for him if he had held the shares in A Ltd personally and made the disposal from a stand-alone structure.
Practical tip
In short, it’s ‘horses for courses’. Whether the advantage I have highlighted on sale from a stand-alone structure outweighs all the advantages of the group structure will depend on what the owners’ ultimate intentions are.
