Taxation Article - The Painless Way Of Splitting

By: Martin Verrall, Rachel Parker
Published on Taxation (http://www.taxation.co.uk/taxation)
Home > Painless way of splitting
16 January 2013
Painless way of splitting
MARTIN VERRALL and RACHEL PARKER explain how the substantial shareholding
exemption works in practice
KEY POINTS
• Degrouping charges.
• Transferring trade and assets into a new company.
• Dealing with goodwill.
• Group transaction.
• Applying for a non-statutory business clearance.
Finance Act 2011 introduced changes to both the degrouping charge and substantial
shareholding exemption (SSE) that, together, mean it is now easier for UK companies
to divest from non-core business activities without incurring a tax charge or costly pre-
transaction restructuring.
Degrouping charges
The degrouping charge has been with us for quite some time and in the past often
proved problematic for UK companies selling off parts of their group.
Although it was possible to take advantage of the UK’s attractive “transactions within a
group” regime (TCGA 1992, s 170 to s 175), whereby assets can be moved around a
group, if the wish was to sell the transferee company, a tax charge would bite.
There were a few options available. For example:
• The asset could be transferred back if the purchaser did not want it, but this was
unhelpful where the capital asset was goodwill associated with the company’s
trade.
• The group could be restructured so that the transferor company was parent to the
transferee, and sell the shares of the transferor. That way the transferee and
transferor were still members of the same group. This caused problems if there
was no intention to sell the transferor, or the purchaser did not want to acquire
the transferor.
• Wait until the six-year window passed, but the opportunity to sell may be lost.
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Finally, capital losses could be used by electing the degrouping charge back into the
group under TCGA 1992, s 179A (repealed by FA 2011).
As a degrouping charge attached to the transferee company, such charges would
excite the advisers on both sides of a transaction and ultimately cost the vendor tax,
sales proceeds and adviser’s fees.
What has changed?
From 19 July 2011, although possible to elect for it to apply to transactions on or after 1
April 2011, TCGA 1992, s 179(3A) to (3H) provides that any degrouping charge arising
on the disposal of shares in a subsidiary forms part of the gain calculation on the
disposal of the shares by the parent.
In essence, as long as the SSE applies to the disposal, the degrouping charge is
exempt from tax and is purely a disclosure on the tax computation when reporting the
disposal to HMRC.
This is an extremely useful revision to the legislation and an easy win in making the UK
an even more attractive place to do business, especially when coupled with the
changes to the SSE.
Changes to the SSE
Also effective from 19 July 2011 (or 1 April 2011 if elected), was para 15A which was
inserted into TCGA 1992, Sch 7AC. This change is less widely understood and few
people have practical experience of its application.
Paragraph 15A extends the period during which a parent company is treated as
holding the shares in a subsidiary company (up to 12 months) by the length of time any
trade and assets transferred to the subsidiary company were previously operated by
another group company.
In theory, para 15A permits the transfer of trade and assets provided they have
operated for at least 12 months, into a newly incorporated subsidiary, the sale of that
subsidiary the same day, and the disposal qualifies for SSE.
Couple this with s179(3A) to (3H) and any degrouping charge on capital assets can be
avoided as well.
Compare this with selling the trade and assets straight out of the existing group
company and this can significantly reduce the tax bill.
There are several practical problems and anti-avoidance provisions to consider, which
are best illustrated by a recent real life example, S Ltd.
Background
S Ltd was founded by Mr and Mrs X in 1985. They have since retired from day-to-day
operations and the business is now run by their daughters. In 2008, Mr and Mrs X
indicated that they were looking at an exit within three to five years.

P Ltd had two main trading activities, a core business and a non-core franchise
business, both of which were run very profitably.
It was decided that P Ltd should divest itself from its non-core franchise business
before the eventual exit because a potential purchaser may not want to acquire the
franchise and, if it did, may undervalue it.
The assets of the non-core business consisted of tangible fixed assets with a net book
value of about £20,000, with goodwill valued at £2.98m: £3m in total.
Mr and Mrs X wanted P Ltd to receive the proceeds from the sale of the franchise
business, without material tax charges arising, so that they could reinvest into the core
activities.
Before the changes introduced by FA 2011, Mr and Mrs X would have received the
proceeds subject to 10% capital gains tax using an Insolvency Act 1986, s 110
demerger and then share sale, or the proceeds could have been put back into P Ltd
subject to a corporation tax charge on the goodwill, either on a straight trade and asset
sale or by way of a degrouping charge on a disposal of shares. Neither of these routes
was acceptable to the family.
During a feasibility study undertaken to determine whether P Ltd could benefit from the
changes introduced by FA 2011 two barriers were encountered: these concerned
goodwill and the requirement for a group.
Old goodwill or new goodwill?
The first barrier concerned goodwill. Until 1 April 2002, intangible assets were treated
as capital assets and taxed under TCGA 1992. However, from 1 April 2002 (now re-
written in CTA 2009, Part 8) intangible assets are treated as revenue items for
companies and have their own distinct set of rules.
For most intangible assets it is obvious whether they are created pre or post April
2002. For example, if a taxpayer buys a licence on 1 January 2012 it is a new
intangible, but the exception to the rule is goodwill.
Under CTA 2009, s 884, if goodwill is acquired from a related party and that related
party carried on the associated business before April 2002, then the goodwill is in its
entirety treated as a pre April 2002, ie a capital asset.
So why does the timing of the creation of the goodwill (or other intangibles) matter?
Well, both old and new intangible assets can be transferred around a group (75%
direct and 51% indirect ownership) tax neutrally under TCGA 1992, s 171 and CTA
2009, s 775 respectively and both will give rise to a degrouping charge if the transferee
leaves the group within six years under TCGA 1992, s 179 and CTA 2009, s 780.
But there is no TCGA 1992, s 179(3A) to (3H) equivalent in CTA 2009.
A degrouping charge on a new intangible asset will therefore still fall to be a liability of
the exiting company rather than forming part of the parent company’s gain calculation
on disposal of the shares.

There is no apparent reason for this mismatch in treatment; it appears that it was
simply overlooked by those drafting the simplification.
It is, therefore, crucial to determine when any trading activity started so that the client
can benefit from these provisions, otherwise it may not be possible to mitigate that
degrouping charge at all.
Fortunately for us, the franchise agreement was dated September 1999, but we then
ran into the second barrier.
Group needed
The second barrier concerns the wording of TCGA 1992, Sch 7AC para 15A. The
conditions to be satisfied are set out at para 15A(2):
• that, immediately before the disposal, the investing company (P Ltd) holds a
substantial shareholding in the company invested in (S Ltd);
• that an asset which, at the time of the disposal, is being used for the purposes of
a trade carried on by the company invested in was transferred to it by the
investing company or another company;
• that, at the time of the transfer of the asset, the company invested in, the
investing company and, if different, the company which transferred the asset
were all members of the same group; and
• that the asset was previously used by a member of the group (other than the
company invested in) for the purposes of a trade carried on by that member at a
time when it was such a member.
All appears as expected at first glance, but the fourth condition implies that the
transferor company (in our case, P Ltd) has to be a member of a chargeable gains
group when it operated the trade. In other words, P Ltd cannot be a sole trading
company.
This is nonsensical. Why should this generous extension of SSE apply only to groups
of companies and not to sole trading companies?
Initially we dismissed this on the basis that we considered that a group of one is still, at
least mathematically, a group (albeit a small group).
Indeed, TCGA 1992, s 170(3) states “a company … and all its 75% subsidiaries form a
group … but a group does not include any company (other than the principal company
of the group) that is not an effective 51% subsidiary of the principal company of the
group”.
Our interpretation is that a group of one can exist (at least, this definition does not
specifically exclude it).
However, in their Capital Gains Manual para CG53080C, HMRC say:
“The provision cannot apply where the transferee company is a newly acquired
subsidiary of what was previously a single trading company.”
On this basis, a single trading company (such as P Ltd) has two choices: undertake the
transaction and claim SSE, stating that this is not in line with HMRC’s published view to

ensure adequate disclosure, and accept an enquiry into the return is probably on the
way; or form a group pre-transaction.
Fortunately, P Ltd had recently developed some software for its own trade that it was
intending to licence out to third parties which, for commercial reasons, could be better
run from its own separate company which overcame the problem.
Anti-avoidance
Taxation of Chargeable Gains Act 1992, Sch 7AC contains an anti-avoidance provision
at para 5. This prevents the SSE applying to arrangements where the sole or main
benefit that could be expected to arise is that a gain is exempt under SSE. For these
purposes, arrangements “includes any scheme, agreement or understanding”.
There is a risk that forming a group before claiming SSE by virtue of para 15A could be
challenged by HMRC using para 5.
If there is material uncertainty for a client, HMRC’s non-statutory business clearance
service can be used.
We made a clearance application to HMRC, which set out the commercial rationale for
the transactions (both setting up a separate company for the IT business and for hiving
down and selling the franchise business), which included:
• reducing the risks (commercial and financial) of the non-core activities to P Ltd by
limiting it to their investment in share capital;
• easier management reporting and review of performance of different business
streams (core, IT and non-core);
• allowing the directors of P Ltd to concentrate on the core trade;
• that a statutory demerger could be used, and from the family’s own perspective
meant cash in their own hands at a 10% tax rate, but this was not commercially
what they wanted; and
• the fact that reduced due diligence, legal and professional fees, in particular in
relation to tax, would be incurred on a sale of a new special purpose entity rather
than a straight trade and asset sale.
The restructuring was staggered so that the IT company was operational from 1 July
and S Ltd was transferred the non-core activities on 30 September, ie P Ltd and IT
company were in a group for three months before. S Ltd would be sold in December.
We received clearance from HMRC that para 15A would apply so that the 12-month
period condition was met and that para 5 would not prevent the exemptions in Sch
7AC applying: we had pre-transaction clearance that SSE would apply.
Other considerations
As with any transaction, stamp duty land tax and VAT need to be considered. A large
stamp duty land tax and/or VAT bill could make the restructuring unviable, but often
they can be avoided. One good example of this is commercial property.
The effectiveness of hiving down a trade and selling the shares, as opposed to a
straight trade and asset sale, relies on the SSE applying to the share disposal. If it
does not, this route can cause a larger tax charge to arise on the disposal because:

Categories: Business [2]
Income Tax [3]
Tax Topic Tags: Comment & Analysis [4]
• a degrouping charge arises on the capital assets of the trade (including old
goodwill); and
• a gain arises on the disposal of the shares which have nominal base cost.
In certain circumstances, as illustrated in Calculations [1], this could lead to a doubling
of the effective tax rate.
In summary
For disposals after 1 April 2011, TCGA 1992, s 179(3A) to (3H) and para 15A together
have given companies and their tax advisers another restructuring tool in their
armoury. When compared with a demerger under Insolvency Act 1986, s 110, it is
considerably cheaper, easier and can be implemented over a shorter time.
From a due diligence perspective, the purchaser can acquire a newly formed company
with very little history and therefore minimal contingent tax (and other) liabilities.
However, it does rely on a purchaser being willing to acquire shares rather than trade
and assets which may have their own tax advantages.
Care must be taken to ensure that any intangibles, especially goodwill, that would be
transferred are old and that a group exists before implementation. I hope wider
publication of the uneven playing field this creates will prompt appropriate revision to
the legislation.
With the right fact pattern, the savings can be significant, as demonstrated by our client
P Ltd, for which the figures are provided in Calculations [1].
Martin Verrall (martin.verrall@uk.gt.com, 01293 554 087) is an assistant tax
manager and Rachel Parker (rachel.parker@uk.gt.com, 01293 554 126) is a tax
manager, both for Grant Thornton UK LLP. They specialise in the taxation of
owner-managed businesses
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[2] http://www.taxation.co.uk/taxation/category/business
[3] http://www.taxation.co.uk/taxation/category/income-tax
[4] http://www.taxation.co.uk/taxation/category/content-type/comment-analysis
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