It has been a while since we last discussed corporate groups, and the notion of intra-group transfers. In this article we shall look at the rules as they apply to investment trusts, VCTs, REITs and other types of company that have a special tax status.
(This article can be downloaded in pdf format at Academia.edu.)
Recall the general rule that intra-group transactions are tax neutral to reflect the fact that a group is, in substance, a single economic unit. In particular, for capital gains groups, assets transferred between group members are transferred on a no-gain no loss basis. It is only when the asset leaves the group that the tax is recovered. An asset can leave the group either by way of a direct sale, or indirectly through a corporate wrapper. In the latter case, we have special degrouping rules to ensure that the tax is paid.
But the group rules don’t apply to investment trusts, VCTs and REITs
We have come across these creatures before – they are all vehicles that invest money on behalf of their shareholders, and benefit from the exemption from capital gains1. They are all excluded from the rules on capital gains groups2:
- An investment trust is a company that invests mainly in shares and securities, though it can also invest in other assets such as land;
- A VCT is a company that also invests mainly in shares and securities – it can be thought of as an investment trust with a specific mandate, namely to invest shareholders’ money in high growth companies;
- A REIT is the property equivalent of an investment trust – investing in real assets, it is also exempt on its rental profits.
There are two other types of company that are excluded from the rules – we shan’t deal with these in any great detail, but it is worth mentioning:
- Qualifying friendly societies – they can be grouped together with investment trusts, VCTs and REITs in that they are also exempt from capital gains on their investment business3;
- Dual resident investing companies which are not in the same category as the others. They aren’t exempt from capital gains, but the dual residence gives rise to arbitrage opportunities4.
In the following discourse we shall concentrate on investment trusts, but similar treatment will apply to the other exempt bodies mentioned. The reason for concentrating on investment trusts is that there is a good example from real life to draw from, and we are also going to be looking at them in greater detail in future articles.
What does it mean when we say that investment trusts are excluded from the rules?
This is actually a piece of loose talk as we shall see. We need to look at the legislation to see just what is and what isn’t allowed.
The exclusion of the no gain no loss rule applies:
“…where the disposal is a disposal by or to…an investment trust [or venture capital trust/REIT]”
A disposal “by or to” – so there are two types of transaction that are caught. The following example illustrates why this is the case.
We shall assume that our investment trust has a subsidiary. This is not unrealistic – until 2012, investment trusts that wanted to invest directly in real assets had to do it through a subsidiary. One such trust was the Value & Income Trust which held its property portfolio through a company called Audax Properties (the properties were recently transferred to the parent).
“A disposal by…”
Consider the scenario where the subsidiary Subco has an asset standing at a gain, which it wishes to sell. This gain is taxable, since the investment trust exemption doesn’t carry over into its subsidiaries. But suppose that the parent trust has an asset standing at a loss, which it also wishes to sell. In these circumstances, the following transactions take place:
- The trust transfers the loss making asset to Subco on a no gain no loss basis. The effect is that Subco stands to make the same loss on selling the asset as its parent would have made;
- Subco sells this asset and incurs a capital loss;
- This loss can then be utilised against the original asset standing at a gain.
If this were permitted, then it would turn an unallowable loss – that of the parent – into an allowable one in order to shelter the subsidiary’s gains. The loss is unallowable for the investment trust as a consequence of the general rule for capital gains – exempt the gain, disallow the loss5.
However, because investment trusts are excluded from the “no gain no loss rule”, the transfer of the loss making asset to Subco is at market value6. This has the effect of extinguishing the loss when the asset reaches Subco – a subsequent sale will not help shelter the gain on the chargeable asset.
“A disposal to…”
Alternatively, Subco can simply transfer the asset to the trust which then sells it tax free. Without the exclusion, the first transfer is a no gain no loss transaction, and the second relies on the investment trust exemption. However, in real life, the first transaction is fully taxable.
One question that may be asked about these two examples. Why is there a need to transfer any assets? Why not rely on the rules in TCGA 1992 s 171A which would allow one company to sell the asset itself and then transfer the relevant gain or loss to its fellow group member?
Of course this section doesn’t apply in any event, since a prerequisite is that a real life asset transfer would have benefited from the no gain no loss rule – and this is not the case where one of the parties is an investment trust7.
However, without this requirement, it would only be possible to shelter the gain in one way. Subco would be able to transfer a gain to its parent, but the latter couldn’t transfer losses back to Subco. For the losses must be allowable in the hands of the party seeking to transfer them, and this is not the case where that party is an investment trust8.
Does this mean that investment trusts can’t be members of a group?
The obvious answer is “Yes”. The correct answer is “No.” As always, we need to look at the legislation for the reason.
First of all, let us repeat what the legislation says about no gain no loss transfers. So far we know that the “no gain no loss” rule doesn’t apply:
“…where the disposal is a disposal by or to…an investment trust [or venture capital trust/REIT]”
Note that it doesn’t actually say that the investment trust, VCT or REIT is not considered to be member of the group. And if we go on to look at the definition of a capital gains group, we see that there is nothing there that excludes these types of company from being a group member either9. Indeed, they are fully entitled to be group members – only they are barred from the benefit of taking part in a “no gain no loss” transaction.
The following diagram illustrates the importance of this distinction:
A and B have a common parent, which happens to be an investment trust. Since the latter is not barred from being a group member, it forms the required link between A and B. The latter are in the same group only because of the investment trust that is their common parent. Accordingly these two companies are able to transfer gains and losses between them on a “no gain no loss” basis.
There is in fact, a real life example of an investment trust group. Caledonia Investments is an investment trust which recently acquired two trading subsidiaries. One is a company called Park Holidays, a caravan park operator, of which Caledonia holds the entire ordinary share capital, and the other is Choice Care Group, a company specialising in nursing homes. Caledonia holds a 98% stake in the latter company10.
Postscript – the Value and Income Trust
As mentioned above, until 2012, investment trusts that wanted their own direct property portfolio had to use a subsidiary. This is due to the old requirement that a trust’s investments had to be mainly shares or securities11 – and indeed the latter is what most trusts tend to have in the portfolio.
The Value & Income Trust is a not a typical investment trust. The portfolio is split between equities, which have always been held directly, the other part is devoted to property which used to be held through a subsidiary. I am grateful to a poster on the Which Investment Trust forums for informing me that the properties were recently transferred to the parent company (see the discussion following the article Coming Onshore – Are Investors better off when Offshore Property Funds Convert to REIT status?)
While this means that the properties can now benefit from the capital gains exemption, the question arises: “Did they transfer the properties tax free?” They couldn’t have relied on the fact that this is an intra-group transfer – so if they did achieve a tax saving, how did they do it?
- TCGA 1992 s 100 for investment trusts and VCTs; CTA 2010 s 535 for REITs. ↩
- TCGA 1992 s 171(2)(c), (cc), (da). ↩
- TCGA 1992 s 171(2)(cd), FA 2012 s 165. ↩
- TCGA 1992 s 171(2)(d) and see the example in the HMRC Manual at CTM34610. Dual resident companies are in a separate class to the other types of company mentioned. As the Manual points out, the exclusion is only one way. Transferring an asset to a dual resident will not be tax neutral, but the no gain no loss treatment will still apply if the transfer is the other way round. ↩
- TCGA 1992 ss 8(2), 16(2). ↩
- TCGA 1992 ss 17, 18, 286 deemed market value rule for transactions between connected persons. ↩
- TCGA 1992 s 171A(1)(c). ↩
- TCGA 1992 s 171A(1)(a) requires a “chargeable gain or an allowable loss” to accrue to the company transferring the gain or loss. Because of the investment trust exemption, the loss can never be allowable. ↩
- TCGA 1992 s 170, and in particular the requirement to be a company under TCGA 1992 s 170(9)(a) being a company as defined by the Companies Act 2006 s 1(1), and TCGA 1992 s 170(9)(cc) an incorporated friendly society within the meaning of the Friendly Societies Act 1992. ↩
- See Caledonia Investments Ltd, Annual Report 2014. page 11. ↩
- The old CTA 2009 s 1159(1) Condition C, and its predecessor ICTA 1988 s 842(1)(a). ↩
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