Replies to Queries - 3 - Return of value?

A taxpayer realised the gain of £80,000 which was covered by reinvestment relief following a subscription for new ordinary shares in his own trading company. The amounts were £40,000 on 2 October 1995, £15,800 on 30 April 1996, £4,200 on 13 September 1996 and £20,000 on 20 March 1997. There were also further subscriptions in 1997.

On 1 November 1995 he also lent the company £20,000 and on 6 March 2001 the loan was repaid.

On these facts, is there a return of value under section 164L, Taxation of Chargeable Gains Act 1992 by reason of the loan predating some of the share subscriptions and being repaid after them?

Section 164L appears not to contain any time limit in relation to the repayment of debts. Accordingly, is reinvestment relief endangered even were the repayment is more than three years after the share subscription?

A second point has also arisen on the same case. The share subscriptions were to raise money for the construction of an annex at the taxpayer's home; the annex was then used by the company as its premises. The company is now ceasing to occupy the annex and one proposal is that the client should buy it back from the company for its current value which is estimated at just over half the costs of construction. Would this impact on the reinvestment relief given, or give rise to any benefit-in-kind? If so, would it be any better to leave ownership of the annex in the company without the company using it?

(Query T15,986) - Lion.

The return of value provisions in section 164L, Taxation of Chargeable Gains Act 1992 (which applied to reinvestment relief share subscriptions made before 6 April 1998) are not as broad as 'Lion' may fear.

Although the repayment of a loan does constitute a return of value, it will only prejudice reinvestment relief if there were 'arrangements' in place for repayment at the time of, or before the date of, subscription.

'Arrangements' for this purpose can be construed fairly narrowly, as the Inland Revenue takes the view that the return of value must be directly linked to the subscription. This could be evidenced by, for instance, minutes which set out the company's intention to apply the subscription proceeds to the repayment of the loan.

In effect, therefore, there is a time limit imposed by section 164L, as a decision to apply the proceeds subsequent to the subscription will not fall within the return of value provisions, and will not prejudice reinvestment relief.

However, 'Lion' says that the subscription was specifically to be used for the construction of an annex to the taxpayer's house, and therefore any value received as a result of this could prejudice the relief. 'Value' in these circumstances would include both direct receipt of cash (for instance if ground rent is charged), and any benefit in kind (which could arise if there is any private use of the annex).

No benefit in kind should arise (and therefore no return of value) if the taxpayer now purchases the annex for its market value. Section 156, Taxes Act 1988 disapplies the normal 'cost of provision' rule for calculating the benefit if an asset has been used, or has depreciated since its construction or acquisition. In this case, the benefit in kind is equal to the market value at the date of transfer - which will be reduced to nil by the taxpayer's payment of the same amount.

This would appear to be the best course of action by the taxpayer. If the annex were retained in the company, a number of problems could arise:

As regards the reinvestment relief claims, section 164L, Taxation of Chargeable Gains Act 1992 denies relief if the arrangements for the acquisition of the shares include arrangements for the return of the whole or part of the value of the investment to the individual. Return of value includes the repayment of any debt owing to the individual, other than a debt which was incurred after the acquisition of the shares. Arrangements include any scheme, agreement or understanding whether or not legally enforceable.

The company here is the taxpayer's own company and so the presumption would be that there was an understanding that the taxpayer would have his £20,000 loan back in due course. However, any such understanding only constitutes an unacceptable 'arrangement' if it forms part of the arrangements for the acquisition of the shares. It seems inconceivable that a loan of £20,000 made in November 1995 could have any connection with a share subscription of £20,000 almost a year later, and still less with a repayment of the loan some five-and-a-half years later. Unless there is something more to connect all these transactions, it seems hardly likely that the Revenue would want to attempt to do so. Loans to family companies are commonly made to tide the company over cash flow problems whereas share subscriptions are normally made to finance fixed capital requirements. That seems to be the case here as the share subscription money has apparently been used for the construction of the annex and so one guesses that it has nothing to do with the loan. On the bare facts given, it would not seem that there should be any problem.

The benefit in kind point is more difficult. The company appears to own the annex, but we do not know whether it simply has a leasehold interest in it or whether it has outright ownership of the freehold of the plot of land. Assuming that the company owns the relevant land outright, it seems arguable that, depending on the full facts, the construction of the annex would have devalued the taxpayer's residence. Nobody wants a building in separate ownership in the back garden. In any event, extension works at private residences commonly cost more than the initial value added to the property but this aspect should no doubt be investigated further.

The proposal that the company should sell the annex back to the client should not affect the reinvestment relief claim, for the same reasons as apply to the repayment of the loan. There will be no benefit in kind charge so long as the client pays the company the full market value of the annex at the time of transfer. This would give rise to a capital gains tax loss for the company, but one which is restricted as arising between connected persons. The market value of the annex should, however, be carefully established. It would not seem that this value is simply the amount which it could be sold for if marketed to third parties through an estate agent. There is a special purchaser here, namely the client, and he will have an enlarged property; the 'marriage value' in returning the full site to sole ownership should not be allowed to accrue entirely to the client. In leasehold enfranchisement cases, the marriage value is split equally between lessor and lessee.

At the very least, there should be an equal split here between the company and the client and one can envisage, on the facts, the Revenue suggesting that most of the marriage value should accrue to the company given its loss of money on the project and the tax benefits already received by the client. - Big Shot.

Extract from reply by 'Bear':

If funds were applied to construction activities on land which is owned by the investor, he seems to have derived an immediate benefit, notwithstanding that the company obtained a lease, tenancy or licence to occupy the premises. There is a corresponding liability under Schedule E. The site should first have been let to the company, although a distinction between tenant's and landlord's fixtures is still relevant.

It is probably not too late to draft the appropriate documentation.

Issue: 3852 / Categories: