Extract from an article by Adrian Rudd (of PricewaterhouseCoopers, Tax Adviser's representative on Technical Committee) summarising the Institute's response to an important proposal by the Inland Revenue affecting companies. It is related to the proposal to introduce a deferral relief for disposals of corporate shareholdings. (This article was published in the October 2000 issue of Tax Adviser.) The required level of investment
The Inland Revenue Technical Note outlining the proposals stated that that relief should be available where the shareholder has a substantial interest in the economic success of the investee company, and where the holding can be said to be part of the shareholder company’s structural business.
The Institute felt that if the conditions for the relief are to be based on an interest in the economic success of the company, then ordinary share capital and voting rights are not necessarily the best criteria for deciding whether these conditions are satisfied. A better criteria might be whether the results of the investee company are consolidated with the results of the shareholder company either under the group consolidation rules of CA 1985, ss.227 - 229 or under the equity accounting rules for associated companies in Financial Accounting Reporting Standard 9.
Paragraph 4 of FRS 9 requires that the interest of the investing group or company must be for the long term and that the investing group or company is in a position to exercise a significant influence over the investee company. It is assumed that significant influence can be exercised where the interest of the investing group or company amounts to 20 per cent or more of the equity voting rights of the investee company.
There may however be cases where a company has a 20 per cent economic interest in an investee company but might not consolidate the results of that company. Accordingly, the Institute proposed that a holding of 20 per cent of the ordinary shares in an investee company should qualify for deferral relief if the shareholder would be entitled to 20 per cent of the profits available for distribution to equity holders and 20 per cent of the assets available to equity holders in a winding up.
The Institute does not support the Technical Paper’s preference for a 30 per cent shareholding, because that would exclude many shareholdings falling within the stated focus of the relief. In particular, it would exclude the case where a company builds up a strategic shareholding in a listed company through market purchases, but which keeps its holding below 30 per cent either because it cannot afford to make an offer for the entire share capital (which under Stock Exchange rules it would be obliged to do if its shareholding were to reach 30 per cent) or because it does not wish to do so.
The operation of the relief
The Inland Revenue’s Technical Paper proposed that the new relief would effectively be incorporated into the existing rollover relief for replacement of business assets. The Institute welcomed this, as rollover relief is well understood by taxpayers, advisers and the Inland Revenue. The addition of a new class of qualifying asset in TCGA 1992 s.155, applying both to disposals and to acquisitions (albeit subject to special rules), would be the simplest and most effective method of operating the new relief.
The Institute saw no reason in principle why close companies should be automatically excluded from the relief, as had been proposed in the Technical Note. The vast majority of companies are close companies and, collectively, they form an important part of the national economy.
The reason that the Government proposed to exclude close companies from the relief is because of concerns that serial entrepreneurs might use companies as a vehicle for their investments. Such companies could take advantage of deferral relief to avoid paying any CGT on disposals of investments, whereas if the investments were owned directly by the serial entrepreneurs some CGT would be payable – even if the disposal qualified for the maximum taper relief, 10 per cent of the gain would be taxable.
However the Institute saw not reason why deferral relief should not be given in these circumstances. If the controlling individual wanted to realise his investment personally, he would have to sell or liquidate the holding company, in which case chargeable gains would arise. In the meantime, the holding company would have reinvested in a qualifying company and there seems no reason for denying relief.
Minimum holding period for qualifying shares
The Technical Note proposed that shares would only qualify for deferral relief if they were held for a period of at least two years. The Institute felt that was too restrictive, pointing out that FRS 9 does not prescribe a minimum period, but simply requires that the investment must be for the long term. The Institute proposed that if the requirements of FRS 9 were satisfied, that should be sufficient for tax purposes. However, if a minimum period was considered to be essential, the period should be one year rather than two.
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