This is the second article in our series on asset rollovers. In Part One, we looked at capital assets, in this part, we shall look at IP (we shall use the term IP to cover all intangibles including goodwill).
(This article can be downloaded in pdf format at Academia.edu.)
Recall that a rollover is a means of deferring tax when a business asset is sold and replaced with another. The idea is that since the sale proceeds have been reinvested, the tax doesn’t become due until the second asset is sold and the funds become available.
What are the differences between capital assets and IP rollovers?
We have discussed this before in the previous article, but it will do no harm to set out the details again:
- Capital asset rollovers are available only to trading ventures, but it doesn’t matter how the business is actually structured. For example, sole traders, partnerships, and corporates all benefit from the relief;
- On the other hand, IP rollovers are only available to corporates, but the business need not be a trade;
- The capital gains relief only applies to specific types of capital asset that are set out in a list. IP rollovers apply to all types of IP, provided that the assets have been brought within the IP tax regime;
- For IP rollovers, there is a special rule where a company can rollover the sale proceeds into shares of another company. This is effectively a look-through procedure, where the business is treated as owning an indirect stake in the IP assets of the company whose shares it has acquired;
- The effect of rolling over IP is to defer the tax by paying it in installments rather than in one go. But for capital gains, no tax is payable until the replacement asset has been sold (subject to the rules for depreciating assets).
We shall now look at how the IP rules work, and how they compare to the capital asset rules.
The IP rollover rules
As we mentioned before, the IP rules are similar to the capital asset rules. However, the language is different – the capital gains rules mention assets being disposed of, while IP rules talk about realisations. However, we shall use the capital gains language here so as to be able to compare the two types of relief.
First of all, this is how IP rollover relief is given:
- The sale price of the old asset and the cost of the new are both reduced by “the amount available for relief.” If all the sale proceeds have been reinvested, this is normally the sale proceeds (realisation) less the cost of the old asset1;
- Note that in the case where the old asset has been written down for tax purposes, the amount available for relief is NOT the amount that would normally be taxed – unlike the case for the capital asset rules where it is the capital gain. For IP purposes, the taxable gain is the sale proceeds less the tax written down value, not the original cost2;
- When computing the tax liability on the old asset, the effect of adjusting the sale proceeds is twofold – part of the gain is brought immediately within the tax charge, the other is subject to a deferral. The part that comes within the charge is effectively a clawback of tax relief already given, as we shall see in the example below;
- Since the starting amount available to write down on the new asset is also reduced, so are the tax deductions. The effect of this treatment is that the deferred gain on the old asset is paid in yearly installments over the useful life of the new asset. It is for this reason that there is no need for a separate rule for depreciating assets;
- If only part of the sale proceeds are realised, only part of the gain is deferred in this way. The amount available for relief simply excludes the amount that wasn’t used to buy the new asset3;
- As with capital assets, all group activities are treated as a single activity – one can rollover IP from one group company into another4. Note that there is no requirement that the assets are held for trading purposes.
What are the time limits for making a rollover claim?
The position is similar to that applying for capital assets:
- Time limit to reinvest the sale proceeds – There is the same “three years forwards one year back” period in which to acquire the new asset – three years in which to make a new acquisition or one can backdate the claim to include acquisitions made in the previous year5;
- Time limit for making a claim – This is four years from the end of the relevant tax year. The relevant tax year is the year in which the new asset was acquired, unless it is a “backdated” claim, in which case time runs from the year in which the old asset was sold6.
Example of how IP rollover works
We shall use some of the numbers in the capital rollover example, to illustrate the difference with the IP rules.
For the old asset we shall assume:
- The original cost is £7m;
- The tax written down value is £5m – in other words, at the time of the sale, the company has received £2m worth of tax deductions;
- The sale price is £10m – and therefore the taxable gain is £5m, being the excess of the sale price over the tax written down value.
For the new asset assume:
- The purchase price is £12m;
- We further assume that this asset has a useful economic life of 12 years. This would normally give rise to an annual tax deduction of £1m.
How does the legislation deal with this set of events? First note that all the sale proceeds have been reinvested, so the full amount of relief is available. According to the legislation, the amount available for relief is the excess of the sale proceeds over the original cost:
Note that this is not the full amount of the taxable gain of £5m. This figure excludes the £2m difference between the cost and the tax written down value. Since the company has already received tax relief for this amount, relief is not available a second time round.
And indeed, it will normally be the case that one cannot deduct the entire taxable gain, when tax relief has already been obtained. One can see this by reference to the relevant formulae. The amount available for relief is:
Proceeds – Cost
And if we note that7:
Tax Written Down Value = Cost – Tax Relief
Then we can rewrite the amount available for relief as:
[Proceeds – Tax Written Down Value] – Tax Relief
Amount available for relief = Taxable Gain – Tax Relief
Returning to our example, the amount available for relief is now deducted from both:
- The sale proceeds of the old asset; and
- The cost of the new asset.
What are the consequences? First, the tax liability on the old asset is recalculated:
So unlike capital asset rollovers, an amount of tax is immediately payable, but it is a reduced amount. The figure of £2m is the amount for which relief has already been given – not a surprise in the light of our previous comments. This part of the cost has effectively been recovered, so it is now clawed back and immediately brought into the tax net.
What about the new asset? If we deduct the amount available for relief, we must recalculate the annual tax writedowns:
So instead of deducting £1m per year, the annual deduction is reduced to £0.75m, or, stated another way, the company’s annual profit is boosted by £0.25m. Accordingly, the reduction of £3m in taxable profits in respect of the old IP is balanced by an increase in profits contributed by the new IP.
Note that £0.25m x 12 = £3m. In other words, the tax on the £3m is in effect being paid over the life of the new asset.
This last fact explains why there is no need for a special rule when IP is rolled over into a depreciating asset. IP assets by their nature are depreciating, and the tax is already being paid.
Interaction between capital and IP rollovers
In Part One, we looked at the rollover relief rules for capital assets. Recall that this type of rollover applies only to those assets that are specifically listed in the capital gains legislation, and that some of these assets are also intangibles. In particular:
- Milk quotas;
- Ewe and suckler cow quotas;
- Fish quotas;
- Payment entitlements to EU farm subsidies.
As far as corporates are concerned, these items should only be eligible for an IP rollover – the idea behind the IP rules being that IP should be taxed as revenue items under a single code.
But what is the position for a company who holds an IP asset that has yet to be brought into the IP regime? The rules do not apply to assets held on 1 April 2002 and which have yet to be sold to an outside unrelated party8. For example, the goodwill in a business sold under an asset sale will be taxed as capital if it is “old goodwill” – does this mean the gain can still be rolled over under the capital asset rules?
The answer is quite simply “no” – certainly not anymore. On the other hand, the gain can still be deferred, but only by reinvesting the proceeds into IP. Conversely, any capital assets that remain capital – land, plant and machinery – these can no longer be deferred by reinvesting the proceeds into the intangibles on the list, such as the milk and fish quotas.
It is a bizarre situation where one is partly within, and partly without the IP rules. The following is a summary of the position:
- On selling an asset on the list, it is taxed as a capital gain, even the IP assets that have yet to be brought into the IP regime – as far as the corporate tax rules are concerned, they continue to be capital items;
- Non-IP assets can still be rolled over under the capital asset rules, but the choice of rollover is now restricted to other non-IP assets on the list – land can be rolled into land, or machinery, but not into goodwill9;
- IP assets on the list can no longer be rolled over into other capital assets – selling a business and rolling over the goodwill into a new factory is no longer possible10;
- Instead, these assets can be rolled over into other IP – including shares in companies that own IP. Taking the last example further, one can use the sale proceeds of the goodwill to rollover into milk or fish quotas – which are on the capital asset list – or even into a patent or trademark, something that wasn’t possible before the IP rules came into effect11.
The actual rollover calculation requires two pieces of legislation. One goes to the IP legislation and calculates the “amount available for relief” – as we have seen, this amount is used to reduce:
- The sale proceeds of the old asset on the one hand; and
- The tax cost of the new asset on the other.
However, the definition of “amount available for relief” has to be modified to take into account the CGT calculation, in order to give the “right result”. The amount available for relief turns out to be the amount of the gain that has been applied towards buying the new asset. One then needs to go back to the capital gains legislation to ensure that the gain is deferred as it should be12.
This brings us to the end of Part Two. The example above illustrates the key difference between the IP rules and the capital asset regime: under an IP rollover, the tax is in fact being paid over time, as a result of lower deductions available on the new asset.
There is one final topic to discuss before we bring this series to an end. This is the idea of rolling over IP into shares, which we shall look at more closely in the next article.
- CTA 2009 s 758(1), (2). ↩
- CTA 2009 s 735(2). ↩
- CTA 2009 s 758(3). ↩
- CTA 2009 s 777. ↩
- CTA 2009 s 756(1). ↩
- FA 1998 Schedule 18, paragraph 55. This is a general rule for all corporate tax claims. For the issue when time begins to run, the HMRC Manual is silent – indeed the relevant section of the Corporate Intangibles Manual CIRD20150 is out of date at the time of writing, giving a 6 year time limit. See however the entry in the Capital Gains Manual at CG60600 which applies for capital assets – it is reasonable to assume the same rule applies to IP rollovers. ↩
- CTA 2009 s 742. ↩
- CTA 2009 s 882. ↩
- TCGA 1992 s 156ZB(3) as amended – a drafting error made it possible for tangible capital assets to be rolled over into intangibles – land into goodwill – a mistake put right by FA 2014 s 62, amending TCGA 1992 s 156ZB and introducing a new CTA 2009 s 870A to claw back the tax relief that shouldn’t have been claimed! ↩
- TCGA 1992 s 156ZB(1), (2). ↩
- CTA 2009 ss 881, 898(1), (2). ↩
- This is the effect of CTA 2009 s 898 and TCGA 1992 s 156ZA, though the calculation is complex. ↩
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