Aricle by Felicity Cullen, Gray’s Inn Chambers.
Published in December 2001 issue of Tax Adviser.
Corporate restructuring tends to increase at times when the United Kingdom (UK) economy is less buoyant than it might be; and it may just be that the UK economy is becoming less buoyant than it has been for some time. It therefore seems an appropriate time to draw attention to a value shifting point that frequently arises in the context of reconstructions, but which is often paid relatively little attention.
Often –as part of the reorganisation of a group’s assets before a reconstruction of the holding company under the Insolvency Act 1986, s. 110 (‘a liquidation reconstruction’) – capital assets owned by one or more subsidiaries are transferred either to other subsidiaries or to the holding company.
If these tax neutral Taxation and Chargeable Gains Act, 1992 (TCGA 1992), s. 171 inter-group transfers take place for considerations which are substantially less than market value, the values of the shares in asset-transferring subsidiaries held by the holding company may be materially reduced; and the provisions of TCGA 1992, s. 30 will be brought into play. (I do not propose to describe in this article precisely how TCGA 1992, s. 30 comes into play as most readers will be familiar with the conditions for its application.)
Assuming that there have been material reductions in the values of shares in subsidiaries and tax-free benefits have been conferred as prescribed by TCGA 1992, s. 30, the disposals of assets by the liquidator as part of the liquidation reconstruction of the holding company will be disposals to which adjustments to the consideration can, potentially, be made by the Inland Revenue under TCGA 1992,s. 30. (The ‘no tax avoidance’ defence provided by TCGA 1992, s. 30(4) will not be available in the factual circumstances under consideration.)
Just and reasonable?
It may well be that, given the essential nature of a reconstruction and, in particular, the feature that there is no substantial change in the ownership of the businesses being reconstructed (see South African Supply & Cold Storage Co (1904) 2 CH 268) it would not be ‘just and reasonable’ for the Revenue to make adjustments under TCGA 1992, s. 30(5) in the context of a reconstruction. This point may have considerable force in cases where clearance has been applied for and obtained under TCGA 1992, s. 139(5) and may explain why there appears to be relatively little concern over the application of TCGA 1992, s. 30 in the kinds of situations under consideration.
However it is in my view,unattractive to rely on a just and reasonable’ defence (rather than a more solid technical defence) to a value shifting issue. In any event, the just and reasonable defence may be far less compelling in the context of partitions, which are a not uncommon form of reconstruction. (Indeed, partitions have been the subject of recent litigation: Fallon v HMIT [2001] BTC 11,103.)
Protection for reconstructions?
My concerns over the application of TCGA 1992, s. 30 in a reconstruction context may be unjustified as, subject to the specific conditions for its application being met, TCGA 1992, s. 139 arguably provides a broad protection from all gains which could arise when a company disposes of assets in a reconstruction. This argument may further justify the apparent lack of concern over TCGA 1992, s. 30 in the context under consideration.
This brings me to the crucial question as to whether or not TCGA 1992 s. 139 does indeed protect against adjustments under TCGA 1992, s. 30 where disposals are effected in reconstructions. In order properly to address this question, it is necessary to look closely at the relevant statutory provisions.
The legislation
Section 30(5) of TCGA 1992 provides as follows:
‘(5)Where this section has effect in relation to any disposal, any allowable loss or chargeable gain accruing on the disposal shall be calculated as if the consideration for the disposal were increased by such amount as is just and reasonable having regard to the scheme of arrangements and the tax-free benefit in question.’ [my emphasis]
The Taxation and Chargeable Gains Act 1992, s. 139(1) provides:'
- Subject to the provisions of this section, where –
(a) any scheme of reconstruction or amalgamation involves the transfer of the whole or part of a company’s business to another company, and
(b) the conditions in subsection (1A) are met in relation to the assets included in the transfer, and
(c) the first-mentioned company receives no part of the consideration for the transfer (otherwise than by the other company taking over the whole or part of the liabilities of the business),
then, so far as relates to corporation tax on chargeable gains, the 2 companies shall be treated as if any assets included in the transfers were acquired by the one company from the other company
for a consideration of such amount as would secure that on the disposal by way of transfer neither a gain nor a loss would accrue to the company making the disposal, and for the purposes of Schedule 2 the acquiring company shall be treated as if the respective acquisitions of the assets by the other company had been the acquiring company’s acquisition of them.’ [my emphasis]
Analysis
It can be seen that TCGA 1992, s. 139(1) operates in such a way as to fix the consideration for a disposal effected as part of a reconstruction at a ‘no gain, no loss’ amount.
The consideration determined by TCGA 1992, s. 139(1) is, in my view, ‘the consideration for the disposal [to be] increased by such amount …’ for the purposes of TCGA 1992 s. 30(5).
The alternative construction of the legislation is that in determining, for the purposes of TCGA 1992, s. 139(1), the consideration which would give rise to no gain and no loss, the adjustment under TCGA 1992, s. 30 is to be made first and the protection of TCGA 1992, s. 139 applied to the adjusted figures.
The former construction is, in my view, to be preferred on the language of the provisions. It follows that it ought to be assumed that an adjustment under TCGA 1992, s. 30 could arise on disposals effected as part of a reconstruction if the requisite material reductions in values of assets have taken place and tax-free benefits have been conferred.
Conclusions
Thus steps should be taken to ensure (so far as possible) that any transfers of assets which take place in advance of disposals in reconstructions are structured in such a way as to secure the protection of TCGA 1992, s. 32. (Rather than relying only on the just and reasonable defence.) This will generally mean that inter-group transfers should take place at not less than the lower of cost or market value.
These assets transfers will often take place for cash consideration to remain outstanding by way of inter-company debt. Care must then be taken to deal with the debt in a tax-neutral way, for example, transferring the benefit of it (if not already there) to the holding company which is to be reconstructed, and transferring it out as a liability of the holding company’s business in a manner consistent with TCGA 1992, s. 139(1)(c) (see above).
Additionally, care must be taken to ensure – so far as possible – that inter-group dividends are not paid out of chargeable profits as defined in TCGA 1992, s. 31 (which could arise on the sort of inter-group transfers of assets referred to above). This will mean that the protection of TCGA 1992, s. 31 can be secured in relation to potential ‘material reductions in value’ resulting from the payment of such inter-group dividends.
Finally on TCGA 1992, s. 30 it may be noted and may be regarded as anomalous that, s. 34 makes special provision for the application of, s. 135 and 136 in the s. 30 context, but fails to deal with, s. 139 – a provision which, in the minds of many, invariably goes hand in hand with the former provisions.
This article is devoted primarily to value shifting issues, but advisers should not overlook the separate issue of the possible application of TCGA 1992, s. 179 (company ceasing to be member of group) in the context of reconstructions. Practitioners will, however, be familiar with the mechanism of transferring vulnerable assets up to the holding company in advance of the reconstruction and this procedure will solve most TCGA 1992, s. 179 issues.
Technical Department
020 7235 9381
December 2001 by Felicity Cullen
