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Substantial shareholdings and intangible assets

Category Technical Articles
AuthorTechnical Department
The Pre-Budget Report (PBR), held on 27 November 2001, announced further consultation on several important proposed changes to the tax system. This article outlines the Institute representations on two of those proposals – the proposal to exempt disposals by companies of certain substantial shareholdings, and changes to the taxation of intellectual property. In both cases consultation has been in progress for some time, and legislation is expected in Finance Act 2002. Article by Adrian Rudd, of PricewaterhouseCoopers, Tax Adviser’s representative on the Technical Committee published in the March 2002 issue of Tax Adviser. Substantial shareholdings exemption

The Pre-Budget Report revealed that the government has decided to proceed with an exemption, rather than a deferral as had been proposed initially. The Institute welcomed this, as the resulting rules will be far less complex.

Definition of substantial shareholding

One of the key issues on which the government is consulting is the size of the shareholding which qualifies for the exemption.

The Institute had previously proposed that the criteria used for equity accounting should be adopted. It understands the Revenue’s desire for an objective test that can function in a self-assessment environment, but believes that some element of judgment would feature in any definition that would satisfy the government’s desire to target structural investments as opposed to portfolio investments. The Institute continues to believe that the equity accounting test remains the most appropriate test for the new exemption.

In view of the government’s reservations about an equity accounting test, the Institute also proposed two alternative tests which might be adopted.

  1. A shareholding would be regarded as substantial if it gives the shareholder control of not less than ten per cent of the voting power in the investee company. A similar definition in Income and Corporation Taxes Act 1988, (ICTA 1988), s. 790(6) has been in use for many years for the purposes of determining whether a shareholder is entitled to credit relief for underlying tax on dividends received from the investee company.
  2. A shareholding would be regarded as substantial if either:

    1. it constitutes a 20 per cent holding as defined in the technical note; or
    2. the shareholder is a member of a consortium as defined in ICTA 1988, s. 413(6) and the investee company falls within s. 402(3) in relation to that consortium – this definition has been in use for many years in connection with consortium relief.

Each of the above tests has a sufficient degree of objectivity, and is sufficiently well known, to be workable in the context of the new exemption.

Trading groups

The new relief will be limited to trading groups. The Institute is concerned that this will exclude many bona fide economic activities from relief. If the government is concerned about tax avoidance, for example through the use of moneybox companies, these should be tackled through specific anti-avoidance provisions, rather than by denying relief to all non-trading groups. The Institute hoped that the decision to restrict relief to trading groups would be revisited.

The degrouping charge

The Institute was pleased to see that rollover relief for Taxes and Capital Gains Tax Act 1992 (TCGA 1992), s179gains will be available to the extent that an actual gain on disposal of the asset concerned would have qualified.

The ability to take the gain in a different company in the group from the chargeable company will also be helpful in many cases.

The Institute is disappointed that there is to be no reduction in the six-year period under s. 179(1)(c). A reduction to two years would be sufficient to counteract any avoidance of tax using the ‘envelope trick’, and would also remove some of the pitfalls in the present legislation, which can catch the unwary.

Dual resident company controlling CFC

The Government proposes that a dual resident company which controls a controlled foreign company (CFC) should be regarded as resident in the United Kingdom (UK) for the purposes of the CFC legislation if it is regarded as resident in another country under the tie-breaker article of the relevant double taxation agreement.

The Institute felt that this will lead to anomalies and may well be in breach of the European Community (EC) Treaty.

It also believes the availability of the exemption is not, by itself, likely to cause parent companies to emigrate. A parent company is unlikely to emigrate purely for tax reasons. In any case, it should not want to emigrate for tax reasons if the UK tax system as a whole is competitive, which is the government’s stated objective for these reforms.

The Institute remains of the view that a targeted anti-avoidance provision is the appropriate way of dealing with tax-driven company migrations. Alternatively, the provision should be restricted to cases where the country of residence is outside the European Union (EU).

Taxation of foreign dividends

The Institute welcomed the government’s announcement that the taxation of foreign dividends will be kept under review. While there is no great desire for change at present, the question of compliance with the EC Treaty will undoubtedly be raised at some stage.

Further, there is no doubt that a great deal of compliance work would be avoided if was no longer necessary to prepare detailed claims to underlying tax relief on foreign dividends.

Under the present system, any dividend carrying eligible unrelieved foreign tax (EUFT) may not be brought within the onshore pooling arrangements (ICTA 1988, s. 806C(1)(c)). The Institute felt that this restriction is unwarranted and should be removed, at any rate in relation to dividends from substantial shareholdings.

Restrictions on interest relief

The Institute believes that the introduction of interest allocation rules would be most unwelcome, but that need not be a quid pro quo for an exemption system given the anti-avoidance provisions in Finance Act 1996 Sch. 9.

Taxation of intellectual property, goodwill and other intangible assets

The Institute welcomed the Government’s review of the taxation of intangible assets. This is an opportunity to replace the existing law, which is a mixture of sundry legislative provisions and case law, with a single coherent regime. The legislation is written in the new ‘Tax Law Rewrite’ style, which makes it easier to understand.

Given this desire for simplicity, the Institute regretted that the government decided to retain the current regime for existing assets. It is proposed that existing assets will remain outside the new system as long as they exist, which means that the dual system will have to remain in place indefinitely. This contrasts with the new regime for the taxation of substantial shareholdings where there is a clear and welcome distinction. The Institute called for existing assets to be brought into the new regime at book value as soon as possible, if not on the start date.

Fixed assets

A large proportion of the complexity in the new rules arises from the policy decision to include goodwill within the regime, and the introduction of a new reinvestment relief within the revenue system. The Institute would have preferred a simpler reinvestment regime, and felt that any revenue loss that might arise would be offset by the benefits to everyone of a simple system.

The Institute believes that generally acceptable accounting provisions (GAAP) should be followed in determining whether an asset is a fixed asset. This means that, in general, the accounting treatment would be followed for tax purposes. The tax treatment would differ from the accounting treatment only if the accounting treatment cannot be justified under GAAP.

Withholding tax

The technical note was silent on the government’s views as to the future of withholding tax on intellectual property flows. The Institute believes that withholding tax is overly complex and outdated and, in line with the government’s strategy for large business taxation as set out in July 2001, should be abolished.

The Institute asked that if withholding tax is retained, there should be a clearance procedure to protect companies which pay gross in good faith. Moreover the Revenue should publish an article in Tax Bulletin setting out the circumstances in which tax is required to be withheld. The rules are complex and cause many difficulties in practice.


Universities, by virtue of their research activities, generate considerable amounts of intellectual property. Much of this does not have any commercial application, but universities are encouraged by the government to become more commercial in their attitude and so they are increasingly looking for opportunities to exploit their intellectual property.

Universities are bodies corporate and within the charge to corporation tax. However, they are also charities and so benefit from the exemptions provided by ICTA 1988, s. 505and TCGA 1992, s. 256. This means that, currently, universities are not taxed on royalty income received on intellectual property that they have developed, since this is income falling within Case III and is within the s. 505 exemption. Also, with the exception of patent rights, they are not taxed on the proceeds of sale of intellectual property, since this is covered by the s. 256 exemption.

Under the new rules, all income and proceeds of sale from intellectual property will fall to be taxed under Case VI and will not be covered by the s. 505 exemption. This is already an issue for universities in relation to the sale of patent rights, since the proceeds fall within Case VI under s. 524. Universities are often advised that where they develop rights that may become patentable, those rights should be held in a subsidiary company. Any profits in that company can then be paid up to the university under Gift Aid, so eliminating any tax liability. In the absence of any extension of the s. 505 exemption, universities will need to set up similar arrangements for all intellectual property which they develop, whether patentable or not, and irrespective of whether it is likely to be sold or retained by the university to generate an income stream. Accordingly, the Institute called for the scope of s. 505 to be extended to cover Case VI profits on all intangible assets falling within the new regime.

Technical Department
020 7235 9381

March 2002 by


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