This is the first in a series of articles in which we explore the tax rules applying to intra-group transactions. The basic proposition is that such transactions are tax neutral. This reflects the idea that a corporate group represents a single economic unit – when assets are transferred between members, ownership remains within the same family. Accordingly no tax is charged until such time that the asset leaves the group.
In this first article, we shall give an overview of what a corporate group looks like. Later articles will look at the actual rules governing intra-group transfers.
(This article can be downloaded in pdf format at Academia.edu.)
There are in fact, two sets of rules, one for capital assets and the other for intangibles such as IP and goodwill (from now on, we shall use the term IP to describe all such intangibles). However, both sets of rules have the same policy that:
- No tax should be charged when an asset is transferred within a group; but
- Intra-group gains or losses should only be triggered when the asset leaves the group.
But first – what is a group?1
Easy to recognise but hard to define! It is best explained by describing how a group can be constructed 2:
- We start with the company at the top – the principal company, which we shall call A;
- Include all of A’s 75% subsidiaries – both direct and indirect;
- For each of A’s 75% subsidiaries, include their 75% subsidiaries;
- Continue the process, always bearing in mind the overriding condition that each member of the group must be an effective 51% subsidiary of the company at the top of the chain.
This is best understood by a diagram.
They are all in the same group, with A, the principal company, at the top.
- B and C are direct 75% subsidiaries of A – so they are in the group;
- D is an indirect 75% subsidiary of A because:
- By its ownership of B, A owns 100% x 50% = 50% of D;
- By its ownership of C, A owns 100% x 50% = a further 50% of D;
Adding the two up, we find that A has a 100% indirect interest in D. Note that it doesn’t matter that D isn’t a 75% subsidiary of the two companies directly above it. Because D qualifies in its own right as an (indirect) 75% subsidiary from A, it doesn’t depend on B and C to be a member of the group.
In our second example, each company apart from A, is a 75% subsidiary of the one above it. But there is a surprising result in store.
Each company is a direct 75% subsidiary of the one above it – so the “75% condition” holds. But are they all 51% subsidiaries of A? In this case, D is the odd one out. A’s interest in D is 75% x 75% x 75% or 42% – short of the 51% threshold. So the group consists of just A, B and C.
What is a 75%/51% subsidiary?
If A has a 75% subsidiary B, then A is beneficially entitled to at least 75% of B’s ordinary share capital 3
- At least 50% of B’s ordinary share capital, together with
- At least 50% of the profits available for distribution; and
- At least 50% of the assets on a winding up.
Note that the number is 50, not 51 (don’t ask me why – I didn’t write the legislation). Note also that A’s interest in B is measured by its economic stake, and not simply by the number of shares it owns. We shall come back to this issue at the end, when we discuss how corporate wrappers can be used for tax avoidance.
Two further points about groups:
- Foreign companies can also be group members 5;
- However, tax neutral transfers can only take place between the UK members – companies that are either UK tax resident, or carrying on a trade in the UK through a permanent establishment 6. In the latter case, it is only those assets that form part of the UK trade that can be transferred in this way.
The definition of a group is actually a lot more complicated (as if it wasn’t complicated already). There are reams and reams of legislation, but we won’t go there today. We have all we need to go on to the next stage.
But before we turn the page, a word on why group companies are required to have economic rights in their subsidiaries.
Because of tax avoidance of course!
In this example, V is to sell a property worth £10m to P, but would prefer to avoid incurring a tax charge. So V and P get together and incorporate a new company Sub, such that:
- V holds 99% of the ordinary share capital, but the shares entitle it to only 1% of the dividends and 1% of the capital on a notional winding up;
- P subscribes £10m to Sub – the purchase price for the property – and is issued with a stake constituting of 1% of the ordinary share capital, but giving the holder the right to 99% of the company’s dividends and capital on a notional winding up;
- V sells the property to Sub for £10m, the purchase price being funded by P’s cash subscription.
Sub is not truly a sub at all. Although V holds the requisite share capital, it doesn’t have the necessary economic rights. So if V sells the property to Sub, a tax charge is incurred in the normal way.
But what would be the position if we remove the condition that the principal company must hold the requisite economic rights?
In this case, Sub would be part of V’s group and the property transfer would be tax free – even though the economic reality is that it has been sold to an outsider. P is not a group member, and yet it has an overwhelming stake in Sub that obliterates any interest V might have.
Substantially all of the rent on the property is paid to P by way of a dividend. P is also the beneficiary of any capital appreciation in the property. When the property is sold, Sub will be wound up, and all but a smidgen of the sale proceeds will then be distributed go to P.
This isn’t the only way a corporate wrapper can(not) be used to avoid a tax liability. We shall come across this in later articles in this series.
The HMRC Manuals have a section on groups at CG45100.
Discussion on what constitutes a chargeable gains group is at CG45110
Discussion on IP groups is at CIRD40030.
- TCGA 1992 s 170 for capital gains groups and CTA 2009 ss 764-773 for IP groups. ↩
- TCGA 1992 s 170(3); CTA 2009 ss 765, 766. ↩
- CTA 2010 s 1154(3). ↩
- CTA 2010 s 1154(2); TCGA 1992 s 170(7); CTA 2009 s 771 ↩
- TCGA 1992 s 170(9)(b); CTA 2009 s 764(2)(c). By foreign companies, we mean entities that are companies in accordance with the laws of a non-UK jurisdiction. ↩
- TCGA 1992 s 171(1A); CTA 2009 ss 5, 741, 775(1). ↩
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