Protecting unrealised capital losses

United Kingdom

Exemption for disposals by companies of substantial shareholdings - Questions and Answers

The Government proposes to introduce an exemption for gains realised on disposals by companies of "substantial shareholdings" made on or after 1st April 2002.

Where companies have unrealised capital losses on "substantial shareholdings" in relevant companies, it may be advisable to take steps to crystallize those losses before 1st April. The legislation is still in draft form but this aspect of it is extremely unlikely to change.

What is the new relief?

The Government proposes to introduce an exemption for gains realised on disposals of "substantial shareholdings" made on or after 1st April 2002.

Who does the relief apply to?

The relief applies to companies who are within the scope of UK corporation tax on their chargeable gains. The relief does not apply to inpiduals who pay capital gains tax (whether in a personal capacity or as trustees).

What happens to unrealised capital losses?

Unrealised capital losses on holdings which will be "substantial shareholdings" after 1st April 2002 may be lost if they are not crystallised before that date. Although this legislation is in draft form pending final comments it is hard to imagine that this aspect of the proposed rules will change. It is probably worth taking steps, therefore, to crystallise losses now. Losses which are crystallised prior to 1st April 2002 can be used in the current year against gains on other assets or carried forward indefinitely and set against gains on other assets (other than shares which will benefit from the substantial shareholdings exemption).

What methods can I consider using to crystallise losses?

The first and the most obvious step to take is to file a negligible value claim before 1st April this year. This may not be possible, however, in all cases as the Inland Revenue only accept that an asset is of negligible value if it is worth considerably less than 5% of its original cost (or March 1982 value). Other possibilities include selling a substantial shareholding for its current value with a call option to reacquire it at a later date for the same price. Alternatively, an overseas group company can be used to acquire the substantial shareholding which stands at a loss. However, careful consideration will need to be given to other tax consequences. In addition, a group guarantee company can be created to acquire the holding which stands at a loss (degrouping issues will need to be carefully considered here).

What conditions must be satisfied in order for the relief to apply?

  • First condition - the shareholding (or the interest in shares) must be "substantial".
  • Second condition - the company which owns the shareholding (the "investing company") must be a "trading company" or a member of a "trading group" for a given period before the disposal and immediately after it.
  • Third condition - the company whose shares are disposed of (the "company invested in") must be a "qualifying trading company" or a "qualifying holding company".

When is a shareholding "substantial"?

Broadly speaking, a shareholding (or an interest in shares) will be "substantial" when it amounts to 20% ownership of the ordinary share capital of the company invested in and 20% of the economic ownership of the company. In more detail, a shareholding will be "substantial" where it represents:

  • beneficial entitlement to 20% of the ordinary share capital of the company invested in;
  • beneficial entitlement to 20% of the profits of the company invested in available for distribution to equity holders; and
  • beneficial entitlement to 20% of the assets of the company invested in available for distribution to equity holders on a winding-up.

In addition, the investing company must have owned the shares (or an interest in the shares) for a period of 12 months in the 2 years prior to their disposal.

How do I know if an investing company is a "trading company" or a member of a "trading group"?

A company or a group must predominately carry on trading activities (or activities preparatory to trading) in order to be a "trading company" or a member of a "trading group" for these purposes. If the investing company only carries on investment activity (so that it is an investment company for tax purposes) it will not be a "trading company". If it carries on investment activity as well as trading activity then provided the investment activity is not "substantial" in comparison to its trading activity it may still qualify as a trading company for the purposes of the new rules. Even if it does carry on only investment business it may still be a member of a "trading group" provided that its investment activities are not regarded as "substantial" when the activities of all members of the group are looked at together. There is no guidance in the new legislation as to what "substantial" means in this context. However, it is believed (and we are seeking confirmation from the Inland Revenue) that the guidance given in relation to the meaning of "substantial" for the purposes of the taper relief legislation will apply to the new rules. It may be necessary to examine the extent to which resources of the group (including management time) are deployed in making and managing investments as compared with the other "trading" activities.

Can a "pure" holding company be regarded as a member of a "trading group"?

Yes, probably, provided that it always owns at least one trading subsidiary. However, this question is not answered expressly by the legislation. We have asked the Inland Revenue for clarification during the consultation process. We understand that their view is that a pure holding company is entitled to regard itself as a member of a trading group for the purposes of the new rules. All intra-group activities are, we believe, to be disregarded in determining whether the group's activities meet the relevant tests. This would mean that, for example, intra-group leases as well as the holding of shares in subsidiaries are ignored. This reflects the Revenues position on similarly worded tests contained in the taper relief legislation.

Do the new rules apply to a holding company which owns a single subsidiary?

No. As currently drafted the legislation requires that the investing company is a trading company or a member of a trading group immediately after (as well as for a period of 12 months before) the disposal. A holding company which disposes of a single subsidiary will not be a member of a trading group immediately after the disposal. We believe this makes the UK less attractive than other European jurisdictions (such as the Netherlands) for an overseas investor (acquiring a single UK company) in deciding where to locate a European holding company.

Are there special rules which apply to shareholdings in joint ventures?

Yes. Holdings in joint venture companies that are "significant" are disregarded in determining whether an investing company is a "trading company" or a member of a "trading group". Instead, a relevant proportion of the activities of the joint venture company are attributed to the investing company. A shareholding in a joint venture company is "significant" if it represents beneficial ownership of 30% or more of the ordinary share capital of the joint venture company.

How do I know if the company invested in is a "qualifying trading company" or a "qualifying holding company"?

The company invested in must be carrying on a trade in order to be a "qualifying trading company" or must be a holding company of trading companies in order to be a "qualifying holding company". Investment activities of any kind may prevent a company from being a "qualifying trading company" if they are "substantial". In addition, certain activities carried on in the course of a trade can only be carried on by "finance companies". These excluded activities include holding and dealing in shares and securities, holding intellectual property and the leasing of any kind of property. "Finance companies" are companies which carry on a banking, deposit taking, money lending or debt factoring business or a business "similar to" any of these. Companies which carry on any of the excluded activities for the purposes of their trades may find that they cannot qualify and their shares cannot be disposed of on a tax-free basis if they are not "finance companies". Companies affected in this way might include those owning tenanted licensed premises, those owning tied or let petrol stations, property development companies letting out property held as trading stock on a short term basis prior to sale and finance lessors.

Can I ensure that a company does not fall within the new rules?

Yes, this is possible but it may be complex and once any relevant change has been made it will be necessary to wait for two years before being guaranteed that a disposal of a substantial shareholding will fall outside the new rules.

Is this a comprehensive guide to the new rules?

No. This is only a summary. If you have a query please seek detailed advice - see contact details below. There are many detailed provisions. The new rules include a further exemption for disposals of options, convertible debt and exchangeable debt ("assets related to shares"). In addition, specific provision is made in relation to repo and stock lending arrangements, deemed disposals and reacquisitions, the effect of the share reorganisation rules on the new relief, the effect of other capital gains exemptions and the position of companies carrying on life assurance business.