When enacted this summer, Finance Bill 2011 will introduce significant changes to the longstanding chargeable gains rules on degrouping charges for assets, which can arise when a UK target is the subject of a share acquisition. In a recent amendment to the current Finance Bill, it will now be possible for taxpayers to elect for the new rules to apply to transactions carried out since 1 April 2011, rather than having to wait for Royal Assent.
What is Proposed?
Historically, where the acquisition of a target results in that company leaving a capital gains group, while owning assets that were acquired in the previous six years by way of a tax neutral intra-group transfer, then a degrouping charge would arise (deeming there to be a taxable disposal of an asset). The charge is calculated by reference to the market value of the assets transferred (at the time of their transfer) to the target company and can be significant where the target has acquired valuable businesses from other entities within the group.
Typically, when a degrouping charge arises on an acquisition, the purchaser will require an indemnity from the vendor in respect of any tax arising. Alternately, the sale and purchase documentation may provide for the gain to be reallocated to a member of the vendor group by way of an election to be delivered upon completion. There can be a real tax cost to getting the deal done (chargeable gains are taxed at corporation tax rates – currently 26 per cent in the UK) to whomever picks up the tab.
Under the new rules, where a degrouping charge arises due to a sale of shares, this charge would be treated as additional proceeds received from the share disposal. If that disposal is exempt from tax as a result of the availability of the substantial shareholding exemption1 (SSE), then that additional consideration attributed to the degrouping charge will also be exempt. Put in the broadest of terms, where a trading group disposes of a trading subsidiary, degrouping charges should no longer be an issue.
There are, however, a couple of traps for the unwary:
- The new rule set out above applies where there is a sale of shares. When a company leaves a group simply because it has issued new shares to a shareholder outside of its group, the old rules will continue to apply;
- There are no equivalent amendments to the associated degrouping provisions in the intangibles regime, which means that if those assets subject to the charge include intangibles that were acquired post April 2002 (in particular, “new goodwill”), then adverse consequences could still arise.
Pre-Disposal Hive Downs
The disposal of individual businesses housed within a divisionalised company has long been problematic – an asset sale giving rise to a chargeable gain for the vendor and a share sale being precluded where the core business is retained. This has put would-be vendors at a disadvantage compared with, for example, a situation where they had operated each division from a separate legal entity, the disposal of which would be exempt where SSE is available.
The SSE conditions are to be relaxed by permitting the usual 12-month minimum holding period for the shares deemed to have been met when the target company acquired trading assets from another member of the group, and those assets have been used for the purposes of a trade carried on by that other group member.
This means that it will now be possible for the vendor to carry out a tax free disposal by hiving down the division to a new company and then selling the shares with the benefit of SSE. The degrouping charge that would otherwise have arisen in respect to the hive-down will also benefit from that exemption. Again, this technique may not be effective where the business includes “new” intangibles.
The new rules, which have been introduced in the name of simplification, represent welcome reform. Nevertheless, their application remains complex and the fact that degrouping charges may still be on point regarding “new” intangibles, including goodwill, means that adequate due diligence remains as important as ever.
1 Statutory exemption from chargeable gains based on participation in an asset.
Chris Ho, Senior Associate, is co-author of this story.
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