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Our client and his wife own and control two private companies, A and B. Each has a 50 per cent shareholding in each company. Both clients are aged over 50 and have owned company A for over 10 years, and company B 50 per cent for 14 years and 100 per cent for 2 years. It is intended to sell company A to company B after May 2002 for approximately £1 million.
We would like readers' thoughts on the tax implications; both companies are trading companies but are property backed.
Our client and his wife own and control two private companies, A and B. Each has a 50 per cent shareholding in each company. Both clients are aged over 50 and have owned company A for over 10 years, and company B 50 per cent for 14 years and 100 per cent for 2 years. It is intended to sell company A to company B after May 2002 for approximately £1 million.
We would like readers' thoughts on the tax implications; both companies are trading companies but are property backed.
We are assuming that the proceeds received by the shareholders will be subject to taper relief and therefore taxable at 10 per cent (company A cost £2; therefore indexation will not be negligible).
Does the fact that the companies are 'related', i.e. controlled by the same shareholders/directors, have any bearing on the taper relief available? Readers' comments would be appreciated.
(Query T15,860) – Taper.
Assuming that taper relief is available is a dangerous occupation, as numerous articles over the past three years have illustrated. In this case, it is nothing new that will deny it, but the old pitfall of section 703, Taxes Act 1988. The effect of the sale of company A to company B is that the shareholders of company B will receive £1 million of company B's money in a form that is not taxable as income; this is a tax advantage compared with receiving the same money as a dividend, and the Inspector will probably seek to cancel that tax advantage.
A very similar arrangement was held to be within section 703 in the cases of Commissioners of Inland Revenue v Cleary, Commissioners of Inland Revenue v Perren (44 TC 399). The transaction was held to fall within section 704D, being one of the prescribed circumstances in which section 703 operates: 'in connection with the distribution of profits of a (close) company' (in this case, company B), 'the person in question' (the vendors) 'receives a consideration … which is, or represents the value of, assets which are available for distribution by way of dividend…' Although the purchase of another company's shares is not 'in connection with a distribution' for accounting purposes, the Cleary case held that it was so for tax.
It would be unwise to proceed without a clearance application, although a clearance application under section 707 would clearly draw the application of section 703 to the attention of the Inspector. If the Inspector chose to apply section 703, the amount received would presumably be charged to tax as a dividend to the extent that company B has distributable profits. The section gives the Inspector wide powers to raise an assessment which 'cancels the tax advantage', and charging higher rate income tax (at an effective rate of 25 per cent), rather than capital gains tax, would appear to do this.
If section 703 did not apply, the fact that the companies are related should not affect the taper relief. The only question is whether the companies qualify as trading companies, which depends on what 'property-backed' means. If the property assets are used for the purposes of the trade, then full relief at the business rate will be available (as the shareholders will have owned all their shares for at least two years, and we are promised 75 per cent taper after two years from 6 April 2002). If the 'property backing' involves rental or other non-trading activities, then the Tax Bulletin article in the June 2001 issue should be consulted for the likelihood that the Revenue will argue that the lower rate of taper applies.
There might also be some concern about the effect on the taper relief available on a future disposal of the shares in company B. If owning company A changed the status of company B, it might reduce taper relief available (whether or not the disposal of A was treated as capital). There might even be arguments about the value-shifting.
All in all, this proposal seems fraught with difficulties. – Leyborne.
The concern from 'Taper' is the level of taper relief that will be available. However, in view of the fact that taper relief is unlikely to be in point as the proceeds are unlikely to be taxed as a capital gain, I do not propose to consider that point further at this stage.
The disposal will probably be caught by the legislation at section 703, Taxes Act 1988, known as the transactions in securities legislation. As such, the amount received will be treated as a distribution and taxed using the Schedule F rate. Assuming that the clients are higher rate taxpayers, this will mean an effective tax rate of 25 per cent on the proceeds.
If 'Taper' believes that section 703, Taxes Act 1988 would not be applied, I would refer him to the case of Commissioners of Inland Revenue v Cleary in which two taxpayers sold one company that they owned to another company that they owned for cash. The facts sound rather similar to those for the clients of 'Taper'. The taxpayers were caught by the transactions in securities legislation.
'Taper' should also refer to the Inland Revenue's Inspector's Manual at reference IM 4517. Once again Example 1 at that reference is strikingly similar to the facts outlined by 'Taper'.
This reference is also of interest as it identifies the only possible lifeline for 'Taper'. Does company A have distributable reserves of £1 million or is company B paying for goodwill and so for future profits? If that is the case, section 703 would not apply and the proceeds would be taxed as a capital gain.
In that case, if it is assumed that all of the other qualifying conditions are met, a sale of company A in May 2002 would qualify for 75 per cent business asset taper relief. The connection between the two parties does not, per se, disqualify a taxpayer from entitlement to business asset taper relief.
'Taper should make arrangements for a clearance letter to be sent to the Inland Revenue in accordance with the provisions of section 707, Taxes Act 1988 to obtain clearance or otherwise. – Hodgy.
Extract from reply by 'The Snark':
If section 703 cannot be applied, it seems to me that most of the conditions for retirement relief are satisfied. It is necessary to confirm that Mr and Mrs Client are full-time working officers or employees of company A. Given the existence of two companies, this could be less than straightforward. However, If A and B are a commercial association of companies within the meaning of paragraph 1(2) of Schedule 6 to the Taxation of Chargeable Gains Act 1992 (on which the Revenue has commented in its Capital Gains Manual at paragraph 63625), full-time working may be demonstrated by reference to one or both of them. If this condition can be satisfied, retirement relief will be given automatically without a claim. If the transaction takes place on or after 6 April 2002, the first £50,000 of gains (each) will be exempt and the next £150,000 reduced by half. The gain eligible for relief may need to be reduced if there are non-business assets but, given the size of the gain, this is unlikely to restrict the relief available. It does not matter that this is a connected party transaction – many such arrangements have been used in the last 2-3 years to exploit retirement relief before it is lost.
Finally, do not forget that a sale of shares will attract stamp duty, albeit a rate of only 0.5 per cent.
