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The substantial shareholding exemption and degrouping charges

Author: Peter Rayney

Published: 03 Nov 2023

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Peter Rayney examines the vexatious ‘M Group Holdings’ degrouping gains case and considers how companies could avoid the pitfalls.

Our corporate gains degrouping provisions found their way on to our statute books in 1968. They were introduced to block so-called ‘envelope trick’ schemes. These arrangements enabled companies to sell valuable assets to third parties without incurring a taxable gain. The planning typically first entailed a company transferring an asset (standing at a substantial gain) into a (possibly new) subsidiary under the ‘no gain/no loss’ rule (for intra-group transfers). 

Commercially, the asset would be transferred at market value in consideration for an issue of shares by the subsidiary. Ignoring deferred tax issues, the subsidiary’s shares had a base cost equivalent to the market value of the asset. Consequently, it was then possible to sell the subsidiary with little or no capital gain. See illustrative example below.

Example – The ‘envelope trick’

Please do not try to do this today! Leaving aside the ‘Ramsay’ principle, the sale of Newco Ltd would trigger a capital gains degrouping charge (under what is now s179, Taxation of Chargeable Gains Act 1992 (TCGA 1992)). This is because Newco Ltd is leaving the ‘Dusty Ltd’ capital gains group having received (within the previous six years) a property under the ‘no gain/no loss’ group transfer rule – and still holds that asset. Consequently, when Newco Ltd is sold to PSB plc, s179(4), TCGA 1992 would require a deemed disposal and (re-acquisition) of the property at its market value (immediately after the intra-group transfer). In this case, the taxable degrouping gain would be some £3m (ie, market value of £4m less base cost of £1m).

However, as we all know, degrouping charges can arise without any tax avoidance motive and in some cases quite accidentally. Similar degrouping provisions are in place for corporate intangibles. For completeness, there is also likely to be a stamp duty land tax degrouping charge (see para 3, Sch 7, Finance Act 2003), but that’s for another day.

Fix you

Since 2000, the sale of most trading subsidiaries would qualify for the substantial shareholding exemption (SSE). This measure was introduced to improve the UK’s international tax competitiveness. However, as the rules then stood, it was difficult to reconcile the possibility of a taxable degrouping charge arising on an SSE tax-free sale of a subsidiary. This anomaly was tackled as part of the Finance Act 2011 degrouping charge reforms. An important part of these changes was adding any degrouping gains to the actual sale consideration on the subsidiary’s disposal. Thus, if the gain on the sale of the subsidiary qualified for SSE, so did the degrouping charge (which was a component part of that gain). 

Where a degrouping charge arose as a result of a hive-down transaction shortly before the sale of the (transferee) subsidiary, the relevant SSE qualifying conditions – notably the 12-month ownership rule – were unlikely to be met. Finance Act 2011 fixed this by introducing a special deeming rule. This provided that the minimum SSE 12-month qualifying holding period would also be met for any period that assets were being used in a trade carried on by the group before being transferred to the ‘departing’ subsidiary company. 

If the gain on the sale of the subsidiary qualified for SSE, so did the degrouping charge (which was a component part of that gain)

When this period was added on to the actual ownership period of the subsidiary’s shares, this ensured that SSE would be available in the vast majority of post hive-down sales. Paragraph 19, Sch 7AC, TCGA 1992 provides a further complementary rule that can be invoked where required. This deems the relevant subsidiary to have been a trading company for the period before it is sold (where it did not carry on a trade before the hive-down).

The relevant legislation is found in para 15A, Sch 7AC, TCGA 1992 and this is what all the fuss is about in the recent Upper Tribunal ruling in M Group Holdings Ltd v HMRC [2023] UKUT 213 (TCC)

It takes two

On a strict reading of the para 15A(2)(d) rule, the transferor must be part of a capital gains ‘group’ while the relevant asset is being used. Thus, there would need to be at least two group members in existence before the hive-down transaction takes place. Historically, HMRC has also applied this strict interpretation of these rules (see HMRC’s Capital Gains manual at CG53080C). 

The Upper Tribunal recently confirmed this analysis in the M Group Holdings case (upholding the 2021 decision by the First-tier Tribunal (FTT)). In this case, the prospective purchaser of the ‘original’ company, M Group Holdings Ltd (MGL), was unwilling to buy the shares in that company since it had significant contingent liabilities. Despite the ‘Group Holdings’ part of the nomenclature, the company was originally a single standalone company.

The key transactions are illustrated below:

MGL claimed SSE on the capital gain arising on the sale of MCS (which would include the degrouping gain on the hived-down goodwill). HMRC rejected MGL’s entire SSE claim on the grounds that MGL had not held the MCS shares for the required 12-month SSE period. Moreover, any SSE claim made using the para 15A deemed extension period failed since the group only came into existence when MCS was incorporated and the SSE ‘extension’ period between the incorporation of MCS and its sale was just 11 months. 

On a prescriptive analysis of the legislation, the Upper Tribunal certainly found it difficult to be persuaded otherwise, even though this produced a different result between standalone companies and those that were part of a group. It concluded:

“We agree with the FTT’s finding that paragraph 15A(3) restricts the period to be treated as holding a substantial shareholding to the period during which the assets were held and used for the purposes of a trade by a company that was at the time of such use a member of the group. ‘Group’ given its ordinary and natural meaning must consist of more than one company. In the context of the legislative provisions and their purpose a group of companies cannot consist of one standalone company.”

I can see clearly now

The M Group Holdings decision confirms that SSE ‘degrouping’ protection for capital gains cannot be relied on by existing singleton companies (ie, where the transferor was not part of an existing capital gains group), unless they are prepared to wait 12 months after a new subsidiary is created (and the trade is hived-down). The para 15A requirement for a group structure appears to be well known by most respectable tax professionals in and around 2015 (for example, this point was included in an article on Intra-group reorganisations – Howard Murray and Sara Stewart, Tax Journal, 6 December 2013, issue 1196). We are therefore left pondering why MGL did not delay the sale of MCS for another month or so.

The decision confirms that SSE ‘degrouping’ protection for capital gains cannot be relied on by existing singleton companies

In the light of the decision in M Group Holdings, it might be prudent for some singleton companies to set up a £100 dormant subsidiary to ensure they have a pre-existing group structure. This would not affect their ‘associated companies’ count for corporation tax purposes.

Nevertheless, in the right circumstances, such as where an existing corporate group has existed for at least 12 months before a hive-down, the effect of these ‘deeming’ provisions means that the hive-down of assets, such as property and (pre-April 2002) goodwill, should obtain the special SSE degrouping protection (as well as normal SSE on the share sale itself).

Similar rules now operate under the corporate intangibles legislation – which would include post-31 March 2002 goodwill/trades. So long as the SSE is available on the main share disposal (including cases where the para 15A extension rule has been invoked), there is an outright exemption from the s780, Corporation Tax Act 2009 (CTA 2009) intangibles degrouping charge (s782A, CTA 2009). However, in contrast to capital gains degrouping charges, there is no deemed disposal and re-acquisition of the intangible assets, and hence no tax-free uplift in the value of the relevant assets.

Peter Rayney FCA, CTA (Fellow), TEP, Peter Rayney Tax Consulting, past Chair of ICAEW Tax Faculty’s Technical Committee and a past President of the Chartered Institute of Taxation.

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