In our last article on corporate groups, we looked at the subgroup exception as it applies to intra-group transfers. We showed, using both numerical and visual examples, why there should be an exception. In this article we shall see how the tax legislation ensures that this is indeed the case. As before, we shall be concentrating on the rules for capital assets – the rules for IP are similar.
But first…a recap – what is the subgroup exception?
Recall that an intra-group asset transfer does not give rise to a tax charge until the asset has left the group, either by way of a direct sale, or by a corporate exit. The idea is that the tax should be deferred because there is no underlying change in ownership until the asset leaves the group.
The subgroup exception applies when the asset transfer takes place between two companies that are part of a subgroup within the main group. No degrouping charge arises if they leave the main group together as part of a subgroup. In these circumstances, it is arguable that there is still no underlying change of ownership, as the asset remains within the smaller subgroup.
Example 1 – back to the envelope scheme
Recall this situation from the previous article, where B transfers a property asset to A. If V subsequently sells B, no degrouping charge arises. This makes sense, as the property remains within the same B-A subgroup, both before and after B is sold to P
What does the legislation say? The legislation says that the subgroup exception applies if one of two conditions – Condition A or Condition B – are satisfied. In this case, it is Condition B that applies1:
- At the date of the intra-group transfer, one of the companies (A) must be a 75%/51% subsidiary of the other (B) – which means that:
- A is a 75% subsidiary of B, so that B owns at least 75% of the share capital of A2;
- A is an effective 51% subsidiary of B, so that B is entitled to more than 50% of the economic rights attached to the A shares3;
- A remains a 75%/51% subsidiary of B until immediately after A and B leave the group.
And this is clearly the case here.
Example 2 – what about Condition A?
What about it? And wouldn’t it have been more logical to write about Condition A before going on to Condition B?
The reason that we looked at Condition B first, is that this relates to the simplest corporate structure where the subgroup involves just two companies. The scenario for Condition A involves three companies:
B transfers an asset to A, and then W is sold. No degrouping charge arises because W-A-B form a subgroup and this subgroup remains intact on the sale of W. Note that Condition B cannot apply here because neither A nor B is a subsidiary of the other.
Condition A applies because4:
- At the date of the intra-group transfer, both of the companies (A and B) are 75%/51% subsidiaries of a third company W;
- A and B remain 75%/51% subsidiaries of W until immediately after they leave the group.
Note that Condition A cannot apply to the envelope scheme in Example 1. There must be three companies involved for this to work. The envelope scheme does have a third company V – applying Condition A we see that:
- At the date of the intra-group transfer, both A and B are indeed 75%/51% subsidiaries of V5;
- After the sale, A and B are detached from their common parent.
So Condition A can’t work in this situation.
Example 3 – companies leaving as a subgroup can trigger a degrouping charge
Recall that in this example, we mentioned that the subgroup exception doesn’t work.
B sells to A and then joins the W-A subgroup to form the W-A-B subgroup. If V sells W there is a degrouping charge. Although A and B leave together as part of W’s subgroup, they weren’t members of this subgroup when the property was transferred.
What does the legislation say about this?
- Condition B is clearly not relevant because at no time are A and B in a parent/subsidiary relationship. So if this is to work, it must be Condition A;
- But Condition A requires three companies, the third being the common parent of the two companies involved in the intra-group transfer:
- At the date that B sells the property to A, V, not W is the common parent. According to the second arm of Condition A, V must remain the common parent until immediately after A and B leave the group;
- The diagram shows the position just before W is sold. V is still a common parent of A and B through its holding in W;
- However, this is not the case immediately after W is sold – at that point, V is totally detached from all the other members of the W-A-B subgroup. It doesn’t matter that W is a common parent both before and after the sale – it is necessary that W is also the common parent at the time of the initial intra-group transfer, which is not the case.
In short, the reason why this doesn’t work is that there is a mismatch between common parents. There are two in this example – but the common parent has to be the same one from start to finish.
Example 4 – departing companies must leave as a subgroup
We mentioned previously that both companies must leave together as part of a subgroup. This is clearly not the case in the diagram below:
Applying the legislation, we see that:
- It can’t be Condition B because A and B do not have a parent/subsidiary relationship; and
- It can’t be Condition A because the common parent V stops being the common parent after both companies are sold.
Now what is the position when A and B are sold to the same company P?
Just looking at the diagram, it is tempting to conclude that the subgroup exception applies. The two parts of the diagram look similar – both A and B are joined as part of a subgroup via a common parent. But the common parent isn’t the same. In one case it is V and in the other case it is P.
So what else doesn’t work?
Example 5 – another look at the envelope scheme
We already know that the subgroup exception applies if V were to sell B. But what would be the position if V were to sell both subsidiaries in the following – longwinded – way:
- First sell A to P – this should give rise to a degrouping charge; BUT
- Can this degrouping charge be avoided if V sells B shortly afterwards – not to P itself, but to A, who is now part of P’s group – so that we end up with this situation:
One can see that A and B are part of a subgroup both before and afterwards. Unlike the previous example, the companies making up the relevant subgroup are the same. What has changed is the pecking order – A is now B’s parent whereas before the transaction, it was the other way round.
In fact, this is the precise reason why this transaction doesn’t work. Both Condition A and Condition B require that the relationship between the various companies remains the same throughout, right up till immediately after the exit point.
This doesn’t happen here – A was initially a 75%/51% subsidiary of B, but stopped being a subsidiary when it was the first company to be sold to P. The fact that B then becomes A’s subsidiary doesn’t matter – the initial parent/subsidiary relationship has been broken and if this is to work at all, at the very least we need B to become A’s parent again. Even if this could be achieved, we fall foul of the rule that the relationship must subsist throughout.
In short, we can’t swap the order around.
Now let’s look at something more complicated.
Example 6 – now it works, now it doesn’t!
In this example, the B-A subgroup is moved directly underneath W, following an earlier intra-group transfer between B and A.
Suppose V were to sell W. Would the subgroup exception apply to the B-A transfer?
Condition B is in point. A is a 75%/51% subsidiary of B to begin with, is still a 75%/51% subsidiary when B is moved underneath W and will remain such when W is sold.
But suppose that W isn’t sold immediately after it acquires B and A. Suppose a further group reshuffle takes place, with A moving up immediately underneath W:
We already know that the subgroup exception applies if W is sold when the group structure looks like the “Before” part of the diagram. Surely it must apply if W is sold when the group structure looks like the “After” part? After all, the same companies W, A and B are still all part of the same subgroup.
The answer is No. It doesn’t work!
The last diagram on its own doesn’t tell the complete story. The key is to look at the position at the initial intra-group transfer and ask whether the relevant structure remains in place until just immediately after the exit point. At the time of the B-A transfer, we had two options:
- The Condition A option with V being the common parent of A and B – this can’t possibly work because after selling W, V will become detached from A and B:
- The Condition B option, with A being a 75%/51% subsidiary of B – this worked as long as A remained underneath B. But this relationship was broken when A was moved underneath W.
What do the numbers look like?
Let us make the following assumptions:
- W was incorporated by V for £1;
- W issued shares to V as consideration for acquiring B. Accordingly, V’s base cost in W increases to the market value of B which is £54m at the date of the transfer;
- All the transactions take place for market value consideration.
We have highlighted the entries which reflect V’s shareholding in whichever company it holds a direct shareholding (initially B, then W).
This is what the numbers look like in the first scenario. V sells W immediately after transferring B across.
There are in fact two degrouping issues involved, arising from two separate intra-group transactions – we shall look at them in reverse order:
- The intra-group transfer of B from V to W – here the group company B is treated as an asset in its own right; and
- The intra-group property transfer from B to A.
The V-W transfer gives rise to a degrouping charge because V’s base cost in W roughly matches the value of the shares. There is nil gain, even though there is a property held indirectly by W, whose value has increased by £4m. So we would expect a degrouping charge here – in fact, this is an envelope scheme with company B making up the contents of the envelope.
As we saw earlier, the subgroup exception applies to the property transfer because A remains a 75%/51% subsidiary of B throughout. Note that if another degrouping charge were applied, then an extra £4m gain would be taxed – but this is in respect of the same increase in value of the property.
Now let us have a look at the scenario where A is moved directly underneath W before the latter is sold. We shall take the last but one row of the previous table as our starting point:
The last line of this table is exactly the same as in the previous scenario. This is not surprising – moving A directly underneath W doesn’t affect the overall value of the W-A-B subgroup as it is an internal transfer.
But as we saw, this internal transfer is sufficient to prevent the subgroup exception from applying. So there are now two sets of degrouping charges, where previously there was only one. And yet both these charges are in respect of the same increase in value of the underlying property asset.
This doesn’t look like a very satisfactory state of affairs. One can apply to have the extra charge removed6 but it really shouldn’t have to boil down to the discretion of the tax authorities. Furthermore, the example we have just looked at relates to a property transfer – if the asset involved IP, we would get the same result of a double charge, but this time no recourse to HMRC to make the necessary adjustment.
For the subgroup exception to apply, both companies must be part of a subgroup, both at the date of the initial intra-group transfer, and when they subsequently leave the group.
However, as we have seen, it can’t be any old subgroup that will do. There has to be a specific link between the two companies:
- Either a direct link of a parent/subsidiary relationship; or
- An indirect link by virtue of having a common parent.
Furthermore, the same relationship must be maintained throughout – from the date of the intra-group transfer until immediately after the exit point. Any break in the link is sufficient to trigger an eventual degrouping charge, even where the break involves the companies being transferred internally within the same subgroup.
This makes it vital to pay close attention to the legislation. As we have seen, although certain types of transaction may, intuitively look right, on closer inspection they may turn out to be dead wrong!
- TCGA 1992 ss 179(2), 179(2ZB); for IP assets, CTA 2009 ss 783(1), 783(1B). ↩
- CTA 2010 s 1154(3). ↩
- TCGA 1992 s 170(7); CTA 2009 s 771. ↩
- TCGA 1992 ss 179(2), 179(2ZA); CTA 2009 ss 783(1), 783(1A) ↩
- Recall that with V and A, the holding can be indirect through an intermediate company B – see the first article on corporate groups. ↩
- TCGA 1992 s 179ZA. ↩
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