The UK's participation exemption for capital gains (the substantial shareholding exemption, or SSE) is to be reformed and simplified, making it easier for UK companies to claim a complete exemption from UK tax on gains on the disposal of shares.
Removal of seller company status requirement
While the UK is a good holding company jurisdiction generally, its CGT exemption for gains on a sale of a company currently lets it down as the exemption is overly restrictive and can operate harshly and arbitrarily. The main issue has always been the requirement that the seller company be either "a trading company" or part of a "trading group" both before and after completion of the share sale in question. Helpfully, that requirement around the seller company's status will now be removed in its entirety as from 1 April 2017 (assuming the Finance Bill obtains Royal Assent).
The other two main requirements will remain namely, in summary, that:
a) At least a 10 per cent holding has been held for over 12 months; and
b) A "trading test" in relation to the target company/target group being sold.
This is a very welcome simplification. Once it has been enacted, it means, for example, that companies in investment groups will be able to sell out trading subsidiaries standing at a gain without triggering a tax charge. It will also make certain exits by way of IPO simpler and will reduce some of the major difficulties around working out whether the exemption is available, particularly for large groups and PE houses. The flipside is, of course, that there will be no allowable capital loss in the converse position but the reality is that such losses are generally of little value.
In addition, the exemption will not now be lost if the company being sold ceases to be a trading company after the sale, unless disposed of to a connected person. This is to reflect the fact that, unless the vendor and purchaser are connected, the vendor is not able to influence whether the target continues to trade, and indeed may find it difficult to ascertain the post-sale trading status.
Removing these requirements within the SSE should very materially improve the efficiency and robustness of the exemption and, by extension, make UK incorporated holding companies more competitive from a tax perspective.
For example, when comparing the UK exemption to the Luxembourg exemption, the UK has retained the key extra requirement that the target company is either "a trading company" or part of a "trading group". However the UK exemption does not contain the Luxembourg requirements around the levels of tax payable by the target entity.
New exemption for companies owned by institutional investors
Separately, a new form of the SSE is being introduced for companies owned up to 80 per cent or more by certain institutional investors, or where the acquisition cost of the selling company exceeds £50 million. A partial exemption is available where the interest of the qualifying institutional investors in the selling company is between 25 per cent and 80 per cent.
The definition of qualifying institutional investors includes pension schemes, charities, investment trusts and sovereign wealth funds. As these are tax exempt entities, the situations in which they hold their investments through a corporate body may be somewhat limited. However, the exemption takes no account of the activities of either the company making the disposal or the company being sold and is therefore available in respect of investment companies and property holding companies, neither of which have previously been eligible. Certain insurance companies (which often do pay tax) are also included in the list of institutional investors.
Currently many such investments are deliberately structured through tax transparent vehicles in order to ensure that these sorts of investors are not prejudiced.
Whether this is sufficient to change that practice remains to be seen.
Please click below for further articles in this newsletter:
Restriction of corporate interest deductibility
Reform of corporation tax loss relief
Extension of corporation tax to non-resident companies
Taxing forms of remuneration
