Replies to Queries - 1 - Retirement sales

We act for a businessman who sold company A two years ago. He owned company B at the same time, and since retirement has devoted substantially all of his time to company B which has ensured an increase in the value of the company. Our client is currently negotiating to sell company B to an unrelated company, C. However, he would like to retain some form of business interest and is considering investing in company C after the sale of company B has been completed. Any investment made would give him only a minority interest in company C.

Do readers consider that the potential investment could be organised so as to qualify for enterprise investment scheme relief, and therefore claw back some of the gains made when he sold company A? The problems seem to be found in paragraph 10 of Schedule 5B to the Taxation of Chargeable Gains Act 1992. Can the proposal be restructured in any way to deal with these problems?

(Query T15,980) - Steve.

The best way to look at this problem is as follows. Two years ago the client realised a gain; it could be a gain on any asset. He is now considering reinvesting that gain by acquiring shares in company C. Does it matter if before investing in company C, he has also sold to it some shares in company B?

I believe that the answer is no. Attention has been directed to paragraph 10, but this applies primarily where the asset disposed of consisted of shares in a company and where the asset acquired is a holding of shares in that company or in a company in the same group. So paragraph 10 prevents the gain on the sale of company B shares from being sheltered by reinvestment in company C, but that does not appear to be the proposal.

Subparagraphs (2) and (3) of paragraph 10 are directed against situations where relief under the enterprise investment scheme is claimed for an acquisition of shares and, at a later time, a further claim under the scheme is made in relation to an issue of shares in a 'relevant company'. The definition of relevant company includes a company in which shares were previously sold and the gain sheltered by the first mentioned claim under the enterprise investment scheme. Alternatively, a relevant company can be one in the same group as the company which was originally sold. So, applying this to the query, if the gain on company A is sheltered by a reinvestment in company C, paragraph 10(2) would prohibit a further enterprise investment scheme claim by reason of an acquisition of further shares in company A.

So far, therefore, the client seems to be safe with his proposal. There are, however, further problems to negotiate, although they should not be insuperable. Obviously the status of company C would need to be researched in great detail to ensure that there has been no disqualifying event, such as a purchase of own shares during the 'period of restriction' which commences one year before the shares are issued. The company would need to apply the money for a qualifying business activity within the timescale set out in section 289, Taxes Act 1988. Equally important is the fact that the sale of company B to company C could constitute 'value received' by the client under paragraph 13 of Schedule 5B. For the purposes of paragraph 13, it would be essential to ensure that the sale of company B constitutes a 'qualifying payment' under paragraph 13(7), and this in turn requires that the acquisition price paid does not exceed the market value of the shares. Share valuations are not necessarily a precise science and no doubt the Revenue could, at a later time, argue that its valuation of company B is lower than the value applied for the purposes of the sale to company C. One way round this would be to say that the price would be adjusted at a future date in the event that the Revenue values company B lower than the price set for the sale, but this runs into the problem that the client has then effectively incurred a debt to company C for the excess price paid and this constitutes a value received by reason of paragraph 13(2)(e).

All in all, this is all standard enterprise investment scheme stuff - a nice idea by politicians, wrecked by Revenue policy people, although to be fair they have tried to make amends in several recent Finance Acts. - Big Shot.

In cases where paragraph 10 may give rise to problems, there can be alternative possibilities. Supposing the B shares were to be sold not to C but to its existing members personally, in ratio of their holdings in C. That would give C effective ownership of B without any group relationship. Paragraph 10 disqualifies group relationships but not associated company status arising from individual shareholders in common. The client could then take up his C shares with untarnished qualification. If the (other) members of C do not wish personally to hold shares in B indefinitely, let them wait until the client has acquired the intended C holding and until the next accounts date and fiscal year-end have both passed, after which they can resell the B shares to C at market value, which it is to be hoped will not be much different from cost.

A group relationship between the two companies will then result, to be sure, but it will not have existed at the time when the client was buying shares in C, and the paragraph does not forbid the company whose capital includes the 'acquired holding' and the one whose shares were the 'initial holding' from becoming part of the same group after the 'acquired holding' is acquired.

Cash flow problems might inhibit the take-up by any C members of B shares appropriate to them under the above ratio but, if the intention is to pass the shares to C eventually, there are two remedies:

A mixture of the two will probably solve the problem. - Man of Kent.

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