Getting To Know The Substantial Shareholdings Exemption

Ken Moody outlines a very useful corporation tax exemption for companies in certain circumstances.

If a parent or holding company in a group decides to sell a subsidiary company, it is quite likely that the gain on disposal will not be liable to corporation tax because of the ‘substantial shareholdings exemption’. This does not only apply to big groups of companies; small groups can benefit too, and it might even be worth creating a group for that and other reasons. 

The substantial shareholdings exemption (SSE) applies broadly where a company sells shares in another company in which it holds at least 10% of the ordinary share capital, which it has held for, normally, twelve months or more. The rules for SSE are not without complexity (as usual!), and it is only possible to give a flavour of the rules in this article.

SSE requires that a capital gains group exists, but there are other reasons why a group structure may be appropriate. It may, for example, be commercially expedient to interpose a holding company (Holdco) over a trading company (Tradeco) to protect the assets of the trading company from claims against Tradeco, or in the event that Tradeco goes into liquidation. Provided the claims of creditors are not compromised, property, cash or investments may be transferred and protected in Holdco. If Tradeco has distributable reserves, the intercompany debt may be extinguished by crediting a dividend to the intercompany account; or a dividend in specie of the asset in question may be paid.

The mechanism for creating the group is quite straightforward. Holdco issues shares to the shareholders of Tradeco in exchange for their shares in Tradeco. By virtue of the legislation on ‘schemes of reconstruction’ involving the issue of shares, etc., (TCGA 1992, s 135), the share exchange is treated as a reorganisation of share capital, with the result that there is deemed to be no disposal of the shares in Tradeco and no acquisition of shares in Holdco. The holdings merge in effect, and the shares in Holdco are treated as if they had been acquired when the shares in Tradeco were acquired, and for the same cost. Applications for HMRC clearances (under TCGA 1992, s 138 and ITA 2007, s 701) are advisable – to the effect that HMRC accepts that the transaction is for bona fide commercial reasons and that they will not apply the anti-avoidance provisions relevant to those sections.

The shares in Tradeco are transferred to Holdco on a stock transfer form (J10). Stamp duty may be payable at 0.5% of the value of the consideration (i.e. the shares in Holdco), which in this scenario would be the same as the value of the shares in Tradeco. However, relief from stamp duty (under FA 1986, s 77) may often be claimed for the straightforward interposition of a holding company. 

As noted, the minimum shareholding in a company that qualifies for SSE is 10%. However, one problem encountered when the parent or holding company of a small group sells a trading subsidiary is that the ‘investing company’ and the ‘company invested in’ must be a trading company or member of a trading group both before and after the sale. So, if a holding company sells its only trading subsidiary, at that point it ceases to be a member of a trading group, and SSE is not available.

There are two subsidiary exemptions to the main exemption. The first exempts the sale of an ‘asset related to shares’ where the main exemption applies, but this relates mainly to options to acquire shares and is not relevant in this context. The second applies where the conditions for the main exemption are not met, but would have been met if the disposal had occurred at an earlier time within two years ending with the date of disposal. 

It often happens, of course, that the purchaser of a business will prefer to buy the assets of the business rather than shares in the company which owns the business, for commercial reasons and because for acquisitions made before 8 July 2015 tax relief was available (to companies) for amortisation of purchased goodwill. 

However, the purchaser will often be amenable to the hive-down of the business into a new ‘clean’ company prior to the purchase of the shares in that company. This does mean, though, that the vendor company will not have owned the shares in Newco for the required twelve months. Legislation (TCGA 1992, Sch 7AC, para 15A) was introduced (by FA 2011) to facilitate that situation. Paragraph 15A extends the period of ownership of shares in Newco by reference to the prior use of the assets transferred by another group company. So, if the trade has been carried on by a group company for more than twelve months before being transferred to Newco, the shares in Newco will be deemed to have been held for the required period.

To return to the second subsidiary exemption, this may apply where a parent or holding company sells its last trading subsidiary. However, the devil is in the detail, being Sch 7AC, para 3(3), but a detailed discussion of what paragraph 3(3) means (if anything) would, I think, not be helpful here. HMRC interprets the legislation as meaning that SSE is available in these circumstances, provided that the ‘investing’ company is wound up ‘as soon as is reasonably practicable in the circumstances’ (see paragraph 3(3)(b)(ii)). Readers will not, however, find this in the HMRC guidance, and since HMRC’s interpretation is questionable, an application to HMRC for an informal clearance is advisable (but see the proposed changes below).

One snag though is that HMRC advise at CG53080C:

‘The provision [paragraph 15A] cannot apply where the transferee company is a newly acquired subsidiary of what was previously a single trading company.’

According to HMRC, because paragraph 15A applies by reference to the earlier use of the assets by a member of a group, it follows that a capital gains group must have existed. Obviously, if a single trading company forms Newco for the purposes of the sale of its trade, it does not become a member of a group until that time, and so the assets of the trade cannot have been in use earlier by ‘a member of the group’. This interpretation is disputed by some experts. 

The Finance Bill 2017 draft legislation deletes the requirements relating to the ‘investing company’. So, for example, if a (non-trading) holding company sells its sole trading subsidiary, there is no requirement from 1 April 2017 that the vendor company should continue to be a sole trading company or a member of a trading group immediately after the disposal. The tortuous sub-paragraph 3(3) is being deleted so that there is no requirement that the holding company should be wound up.

Unfortunately, no changes are proposed to the legislation at TCGA 1992, Sch 7AC, para 15A, and so the HMRC view as above will presumably still remain.

Briefly, if a chargeable asset is transferred between group members, this is treated as being on a ‘no gain/no loss’ basis; but a ‘de-grouping’ charge (under TCGA 1992, s 179) applies if a company leaves a group within six years of acquiring an asset from another group member (in order to prevent a practice known as ‘enveloping’). The asset is treated as disposed of and reacquired at its market value, and the gain is added to the gain on the sale of the shares of the company leaving the group. This would be an issue if a trade is transferred to Newco shortly before the sale of the shares in Newco, except that SSE exempts the whole gain. Note, however, that this does not apply to ‘post-FA 2002 goodwill’ and other intangible assets (within CTA 2009, Pt 8), where a de-grouping charge may arise. 

Where there is any likelihood that the shareholders of a company may wish to sell the business in the foreseeable future, it may be advisable to create a simple group structure by interposing a holding company at least twelve months before any anticipated sale. Or, perhaps, even more simply, to incorporate a £100 dormant subsidiary. In the event that a purchaser requires a transfer of the business to a ‘clean’ company, there will thus be earlier use by ‘a member of the group’. Newco should, however, trade before the disposal (i.e. the transfer cannot be simultaneous with the sale).