MALCOLM GUNN FTII, TEP examines a new capital gains tax relief due to be introduced next year.
IT IS JUST what thousands of taxpayers have been requesting for decades. Here finally is the very tax relief in black and white in an Inland Revenue document. Unfortunately most of those who have been making the requests are precisely those who are to be excluded!
MALCOLM GUNN FTII, TEP examines a new capital gains tax relief due to be introduced next year.
IT IS JUST what thousands of taxpayers have been requesting for decades. Here finally is the very tax relief in black and white in an Inland Revenue document. Unfortunately most of those who have been making the requests are precisely those who are to be excluded!
What we had in an Inland Revenue Technical Note dated 23 June 2000 were firm proposals for a smart new capital gains tax relief. It would operate by extending the existing business asset rollover relief to certain shareholdings in trading companies or in the holding company of a trading group. All down the years, it has been a constant criticism of the capital gains tax régime that switching out of Shell shares and into BP shares necessarily involved capital gains tax calculations and probably a large liability on selling the Shell shares. There was therefore less to reinvest in BP, but as far as the taxpayer was concerned nothing had been withdrawn from the portfolio or enjoyed personally and all funds remained invested on the stock market. One could see the force of arguments on both sides; the Revenue would say that a gain had indeed been realised so why should it not pay its tax, and the taxpayer would say that the value of his share portfolio before and after the transactions was virtually identical, so the alleged gain only existed as a concept.
As the years have gone by, the problem has become an acute one for those with longstanding share portfolios and there is no doubt that this has contributed to the might of the institutional funds on the stock market which can buy and sell tax free whilst private funds are severely hampered. Some sixteen years ago a unit trust company set up a specially designed umbrella scheme so that taxpayers could switch between different portfolios without incurring a capital gains tax charge, but the High Court (in a stamp duty decision) held that it was ineffective (Arbuthnot Financial Services Limited v Commissioners of Inland Revenue [1985] STC 211). Rumour has it that astute wealthy families get round the problems by setting up their own family authorised unit trust and this accounts for some of the odd and unheard of unit trusts with enormously high charges listed in the Financial Times.
Persistence pays off
The representations over the years about this situation have apparently not entirely fallen on deaf ears. A Technical Note issued on 23 June 2000 by the Revenue proposed a form of rollover relief into new share acquisitions, but crucially this is to be confined to corporate investors; there is at present not the faintest hope that individual shareholders will benefit. At least, however, we have a step in the right direction.
The Technical Note sought representations within a seven-week timescale which has already expired – and although this has probably stifled a certain number of responses which might otherwise have been made, one guesses that the short timescale is rather more symptomatic of the frenzied style of work within our current political circles than anything else. The comments here therefore are not designed to stimulate more responses to the Technical Note, but rather to alert readers to the broad shape of a new tax relief which seems certain to be introduced next year in one form or another. Transactions which are planned for the near future could usefully be deferred until 1 April 2001.
The reasoning
Since the proposed new relief cuts against the whole structure of capital gains tax as we have known it since 1965, it is important to understand what has brought about the notion that a change must be made. The Revenue's Technical Note refers to the fact that many overseas countries have some types of relief for dealings in substantial shareholdings by corporate investors and the Government clearly does not wish the United Kingdom to be left behind in the international marketplace. The note also acknowledges that capital gains tax is a major inhibition on the proper management of a company's business in that it may hold on to a trading subsidiary for the bad reason of avoiding a tax charge on the disposal of it, rather than the good reason of selling it on to someone who could manage it better. Furthermore, the existence of rollover relief encourages the sale of business assets rather than the outright sale of shares in a company which, in terms of national economics, might be the better thing to do.
Close companies included?
The current intention is that the new relief will apply to all companies, including the United Kingdom branches of non-resident companies, so long as the company concerned is within the charge to corporation tax on chargeable gains. However, the Revenue is cautious about including close companies in the relief. The worry is of course that wealthy individuals might be encouraged to form their own investment company so that it could be used as the vehicle for actively managed tax-free investment in substantial shareholdings. Since taper relief offers an unprecedented tax rate of 10 per cent after four years for 5 per cent or more shareholdings, one might have thought that this would not be too much of a worry. However, the Technical Note points out that the current structure of capital gains tax is that some tax is always to be paid by private investors switching shareholdings and including close companies in the new relief would therefore militate against this. The note acknowledges that there are arguments the other way but indicates that close companies are likely to be excluded, although representations were invited.
Qualifying shares
The new relief will be firmly anchored to shareholdings in companies carrying on trading activities. This is expected to include property-based trades such as dealing or property management, but not property investment for letting. The trading test might be based on the taper relief rules or, alternatively, there might be a more flexible test allowing more substantial investment activities but operating an apportionment of gains to be rolled over so that the proportion attributable to investment activities of the underlying company would be excluded. The Technical Note veers towards adopting the taper relief test as this would be simpler.
Shares, of course, come in all shapes and sizes with whatever rights are dreamt up by the lawyers acting. The Technical Note leans towards qualifying investments being ordinary share capital linked in with the complex 'equity holder' rules in Schedule 18 to the Taxes Act 1988.
One of the points to be settled after the consultation exercise is the level of investment which will qualify as 'substantial' so as to be within the new relief. Powerful representations have been made to the contrary, but it seems that the minimum shareholding will be set at 30 per cent. The representations argue for 20 per cent which corresponds to the level at which an investment must normally be accounted for as an associated company.
There is then the problem of how to deal with part disposals. For example, if a 40 per cent shareholding were acquired and after a few years one half of it is sold, should only that one half qualify for the new relief, since the remaining shareholding falls under the threshold, or should all part disposals potentially qualify by reference to a formula? In the latter case, for each part disposal one would look to see how many years it had formed part of a larger shareholding which was in excess of 30 per cent and then that number divided by the total holding period would be the fraction to apply against the gain to give the relief.
The Revenue proposes that there should be an additional qualifying test, that the shares being sold have been held for a minimum period of two years. Views were invited about this, but it seems doubtful whether there will be any complaints since two years is pretty short term in the overall scheme of the universe.
The shares to be acquired
Since there is to be a minimum holding test, the question arises as to how one deals with successive acquisitions in a company by way of reinvestment. Should one look to see whether all the acquisitions take investment over the 30 per cent level so that they can all qualify or should only the particular investment which goes over the threshold be the qualifying investment? According to the Revenue's note, it prefers the simple solution of giving relief only for the investment which takes the holding over 30 per cent, plus any further acquisitions after that time.
Clawback
Some continuing conditions will obviously have to be satisfied, and these are outlined in the Revenue's paper. They include the cessation of trade by the company in which the investment is made, or the subsequent failure of the company to meet the qualifying conditions; or alternatively the investing company might cease to hold the minimum percentage of shares without any disposal taking place, as where a rights issue is declared which the company fails to take up, thus causing its shareholding to fall below 30 per cent. There would also be some 'return of value' rules which one hopes would be less complex and capricious as those in the enterprise investment scheme legislation although, given the constant grafting of old legislation into new, the chances probably are that similar provisions would resurface.
Link with rollover relief
The Revenue appears to prefer linking the new relief with the existing replacement of business asset provisions (section 152 et seq, Taxation of Chargeable Gains Act 1992) so that:
(a) to achieve full relief the whole of any disposal proceeds would have to be reinvested (contrary to the enterprise investment scheme which requires only reinvestment of the gain); and
(b) the same rules and time limits would apply, as currently apply to business asset rollover relief; and
(c) it would be possible to sell other qualifying assets, such as goodwill or land, and reinvest the proceeds in qualifying shares.
Generally
It is too late now to have any input on the policy process with this proposed new relief, but first impressions are that it will transform the corporate mergers and acquisitions landscape. Although the relief is no more than a rollover and there is no tax exemption as such, the ability for corporate groups to buy and sell subsidiaries free of tax liability on gains will mark the beginning of the whole new corporate tax era. Further details will appear in the Green Budget in November, but if the legislation follows the enterprise investment scheme formula, it will apply to gains realised and reinvested after a forthcoming date, probably 1 April 2001. There must be some hope, however, that the new relief might allow existing gains to be sheltered by it so long as the reinvestment is made after the date to be announced, because if it is linked in with existing rollover relief there would seem to be no reason why it should have an entirely fresh starting date for sale and reinvestment.
Whilst the corporate sector will be well pleased, there will no doubt be complaints on behalf of the self-employed sector that a new and unnecessary dividing line is being drawn in the rollover relief legislation. Perhaps there remains a hope that the Government will be open to persuasion about this; ask persistently and you never know what you might receive.
