In Part One, we saw how the degrouping rules prevent capital assets from leaving a group tax free within a corporate wrapper. This article finishes off with a few miscellaneous, but important points concerning the operation of these rules.
(This article is Part Two of a two part mini-series on the Capital Gains Degrouping Rules. Both parts can be read in a single article in pdf format which can be downloaded at Academia.edu.)
All intra-group transactions are tax neutral, as they take place within the same economic unit. When a company leaves a group, still holding an asset acquired from a fellow group member, a degrouping charge arises if the acquisition took place within the previous 6 years. This degrouping charge – which may be a loss – is intended to revoke the tax neutral status of the original transaction.
Company leaves the group – notional sale and buyback of “intra-group asset”
We saw last time that the degrouping charge is calculated by pretending that the exiting company (“Company A”) sold and bought back the asset immediately after having acquired it from its fellow group member. The consequence of this notional transaction is that the tax burden lies in the first place on A. However, if A is leaving the group by means of a share sale, it is the seller that bears the burden.
This brings us to the first point of note.
A tax charge on assets becomes a tax charge on shares
This is actually quite a powerful statement. When the degrouping takes place as a result of a share sale, the degrouping charge is transferred from the company leaving the group, to the group member selling the shares.
However, it is not simply a case of transferring liability from one company to another. In the envelope scheme, Newco is deemed to have sold the property on leaving the group, but V’s liability is deemed to arise on its shareholding in Newco itself. This is a direct consequence of adding the degrouping charge to the purchase price in V’s capital gains computation1.
What would be the position if the Newco shares qualify for a tax exemption? In these circumstances the degrouping charge on the property is actually extinguished. This is the result of transferring the taxable gain on the property to the exempt gain on the shares. And yet a direct property sale would have been fully taxed! We shall discuss this concept in more detail in a later article.
How can a company leave the group?
This transformation is only possible when the company leaves the group by means of a share disposal – for example, when the company is sold. But an exit is also possible by the sale of a company further up the group chain. For example in the diagram below, A has left the group on the sale of its immediate parent C.
This time, the degrouping charge is added on to the sale price for C, not A – A is not being sold. Note that C doesn’t actually own the asset itself. Furthermore, one doesn’t need to sell the entire company. For example, a holding of 100% can be diluted by selling more than 25% of the share capital.
The next diagram shows how a company can leave a group without a share disposal.
- V can simply sell 90 A shares to P; or
- A can issue 900 shares to P.
In either case, A leaves the group, as V’s stake is diluted to 10%.
We have seen that on a share sale, it is V, the seller who bears the degrouping charge. But if there is no share sale – as is the case where the shares are issued – the degrouping charge remains with the asset, and is primarily borne by A.
There is however, a caveat. If the value shifting rules apply when A issues the shares, the dilution of V’s shareholding is deemed to be a partial sale2. According to HMRC, this would mean that A has left the group by means of a share disposal after all3.
It is not entirely clear to me why this should be the case.
The words of the legislation state that the purchase price adjustment is made “if company A ceases to be a member of the group in consequence of” a share disposal(s.)4. This phrase gives the impression of cause and effect – company A leaves the group because shares have been disposed of. But in the above situation, this is not what has happened. It is the issuing of the shares to P that has caused A to leave the group, not the deemed share sale from V to P5.
Allocation of degrouping charge to other group members
So far, we have shown that the degrouping charge falls either on the company leaving the group, or the company that sells the shares resulting in the degrouping. However, it is possible to allocate the degrouping charge to other group members6.
This is a useful option if these other members have losses or gains of their own, that can be set off against the degrouping charge, and therefore lower the group’s overall tax burden.
To summarise the main points arising from Part One and Part Two:
- The object of the degrouping rules is to prevent assets from being smuggled out of a group tax free, under the protection of a corporate wrapper;
- Degrouping charges – which can include a loss – arise when a company leaves a group, taking with it assets acquired from fellow group members within the previous 6 years;
- On exit, there is a notional sale and buyback of the asset at market value, deemed to have taken place immediately before the relevant intra-group transaction, but recorded in the last accounting period;
- When a company leaves a group by means of a share disposal, the degrouping charge is included in the capital gains computation for the shares;
- In other cases, it is the exiting company that bears the tax charge;
- However, in both cases, the degrouping charge can be surrendered to fellow group members;
- In both cases, the company’s base cost in the asset is re-set to market value at the date of the relevant intra-group transaction (NOT at the point of exit).
In our next article we shall discuss the IP degrouping rules. We shall see the treatment of IP is similar to that applying to capital assets, but with some important differences.
- TCGA 1992 s 179(3A), (3D). ↩
- TCGA 1992 s 29. Value shifting is a complicated form of tax avoidance, which includes the case where a company issues shares, as shown in the diagram. We say that value has passed from V’s shares to P’s. Although V has done nothing with its shareholding, the economic effect is the same as an actual sale. The tax legislation deems there to have been a sale if V exercised its control over A to issue the shares to P. ↩
- HMRC Manual CG45420. ↩
- TCGA 1992 s 179(3A)(a). ↩
- Note that A’s issuing shares to P doesn’t constitute a share disposal either. ↩
- TCGA 1992 s 171A. ↩
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