We have seen in previous articles how the degrouping rules operate to prevent the use of a corporate vehicle to shelter taxable gains. There are two sets of rules, one for capital assets and the other for intangibles (“IP”). In this article we shall look at how these rules differ, giving a specific example involving a business sale.
(This article can be downloaded in pdf format at Academia.edu.)
Recall that when a company leaves a group, it incurs degrouping charges in respect of assets acquired from fellow group members within the previous 6 years. When the departure is by way of a share sale:
- The capital gains degrouping charge is added to the purchase price. Primary liability is with the company selling the shares1. By contrast:
- The IP degrouping charge is primarily borne by the company leaving the group2.
This difference is crucial. Consider the following example of V, a trading company intending to sell one of its operating divisions to P. V hives down the trade to a newly incorporated subsidiary Newco, which can then be sold with the benefit of the substantial shareholding exemption3.
However, the sale of Newco is not completely tax free. There are still degrouping charges to consider in respect of the assets transferred under the hive-down arrangement. And it is here that we see the key difference between capital assets and IP.
The degrouping charge for capital assets is extinguished because the liability is transferred to the Newco shares, which are exempt. However, the IP assets do not benefit from this treatment. There is therefore an IP tax charge which falls on Newco when it is sold to P.
In one sense, this is a logical result, in another sense this is quite bizarre.
Firstly, the degrouping charge for capital assets is of a capital nature (obviously), and remains so when it is included in the tax computation for the shares. On the other hand, IP tax charges are always treated as income, even when the amount in question is of a capital nature. To add the IP degrouping charge on to the purchase price would be a radical transformation from income to capital.
On the other hand, this is still a strange result. The substantial shareholding rules were modified to permit the hive down of a business to a new company that could then be sold tax free. But this is not the case if there are outstanding degrouping charges incurred in consequence of the hive down. Accordingly, where the main value of a business is in its IP, or there is a lot of goodwill, there is little benefit in following this route.
But there is some good news – what if the business includes old goodwill?
The intangibles regime covers IP assets created or acquired after 1 April 2002. Assets created before this date, but not yet sold to an independent party – “old IP” – are not included4. In particular, old goodwill is still governed by the capital gains rules. So if, in our hive down example the business includes old goodwill, this latter is included in the capital gains degrouping charge and is extinguished as a result of the share exemption.
Share sales – how does P protect itself from degrouping charges?
Since primary responsibility for the IP degrouping charge falls on the company leaving the group, the buyer P, will require protection in the sale documentation. However, while P can discount the purchase price and obtain a suitable indemnity in the Tax Deed, there is always the issue of having to contact V if something goes wrong. What if V disputes the claim, or has gone bust in the meantime?
These issues used to be the same for both capital assets and IP where the share sale took place before 19 July 2011. At that time there was no facility for transferring the degrouping charge onto the shares – the rule for adding it onto the purchase price is quite recent5.
Capital assets are now treated differently. The degrouping charges automatically fall on V, including any unexpected liabilities that may resurface after P acquires Newco. HMRC is not going to look to the target company for the tax, and so there is no need for P to go back to V to be reimbursed. This is a far more favourable position than is the case with IP.
- The key difference between the capital and IP rules is the treatment applying on a share sale. For capital assets, the degrouping charge is transferred to the company selling the shares, for IP, the charge remains with the company leaving the group;
- As a consequence, capital gains degrouping charges are extinguished on an exempt share sale, but IP degrouping charges still stand;
- The hive down of a business followed by a share sale is not totally tax free, even if the substantial shareholding exemption applies. If there is substantial IP or goodwill, these items will attract degrouping charges. However, this may still be a feasible proposition where the IP or goodwill is still treated as a capital asset under the old rules applying before 1 April 2002.
There are further differences between the capital and IP regimes, such as the treatment of reinvestment relief. We shall look at this topic in a later article.
- TCGA 1992 s 179(3A), (3D). ↩
- CTA 2009 s 780(2). ↩
- We shall assume that all the necessary conditions apply. In particular, we shall assume that the trade has been part of V’s group for at least one year – TCGA 1992 Sch 7AC, paragraph 15A. ↩
- CTA 2009 s 882. ↩
- FA 2011 s 45, inserting the provisions under TCGA 1992 s 179(3A)-(3H). ↩
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