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Two recent replies ('Taperly ever after', 27 June and 'Trapped in a taper relief corner', 4 July) have suggested demergers or section 110, Insolvency Act 1986 liquidations to restart the capital gains tax taper relief clock where there are investments, etc. which might cause business taper problems.
In the Explanatory Notes to clause 46 of, and Schedule 10 to, the Finance Bill 2002, it says (at paragraph 44):
Two recent replies ('Taperly ever after', 27 June and 'Trapped in a taper relief corner', 4 July) have suggested demergers or section 110, Insolvency Act 1986 liquidations to restart the capital gains tax taper relief clock where there are investments, etc. which might cause business taper problems.
In the Explanatory Notes to clause 46 of, and Schedule 10 to, the Finance Bill 2002, it says (at paragraph 44):
'Because the new provision relates to the company in which shares were held at any time, the effects will be more easily predictable, especially in cases where a company is reconstructed. A person might hold shares in company A and exchange them for shares in company B in circumstances where the capital gains tax rules provided for the share exchange not to be treated as a disposal. The assessment of whether the shares were shares in an active company would be made in relation to the company in which shares were actually held at the time, that is initially company A, [then] after the date of the exchange company B. The provision will therefore work in the same way as the assessment of entitlement to business assets taper relief in share exchange cases.'
I can find nothing in Schedule 10 which says this, and it must refer to the effect of removing the 'relevant change of activity' provisions. Does this mean that the taper clock will not be restarted in demerger situations or other reconstructions under section 135, Taxation of Chargeable Gains Act 1992, et seq, and not just demergers but all such reconstructions where there is no immediate capital gains tax charge?
(Query T16,086) - Confused.
Paragraph 44 of the Notes on Clauses in the Finance Bill 2002 relates to what is now paragraph 3 of Schedule 10 to the Finance Act 2002. This is the new rule which suspends taper relief during any period when the asset concerned is shares in a close company and the company is not active. The paragraph details those functions which constitute being active, and those which constitute being inactive.
This is different from the previous rule in paragraph 11 of Schedule A1 to the Taxation of Chargeable Gains Act 1992 which provided that, where there was a relevant change in activity by a close company, the taper relief clock restarted for all shareholders.
Paradoxically, the former paragraph 11 could be put to good use to help the shareholders with their taper relief problems. For example, if a close company failed to qualify as a trading company because it held too many investment assets, it might have been possible to carry out a reconstruction by which the trading activities were transferred to a new company which would carry on the trade. Although the paragraph dealt with situations in which there was a group of companies, there was nothing in it which suggested that, in demerger situations, the new company should be treated as a continuation of the previous company. Thus paragraph 11 applied to the demerger company since it was a close company commencing to trade.
The demerger would have been structured so as to fall within the capital gains tax reconstruction provisions so that there was no disposal of the original shares for capital gains purposes. Nevertheless the new shares in the demerged wholly trading company would acquire a clean sheet for taper relief purposes with the clock restarted.
That provision has now been repealed and in its place is the inactive company rule. As paragraph 44 in the Notes on Clauses explains, the rule is applied continuously over the whole period that shares in a particular company are held; where the shares are converted into other shares, or where there is a demerger, there is a no disposal fiction for capital gains purposes and so the relevant period becomes the whole period of holding the former and the new shareholdings.
As is pointed out in the query, opportunities for restarting a taper clock by means of demergers in close company situations no longer exist. There are of course other well-tried and tested ways of achieving this result, including the transfer of the shares to a settlor-interested trust with the benefit of holdover relief under section 165, Taxation of Chargeable Gains Act 1992. - Bigshot.
Under section 135, 160 or 419, Taxation of Chargeable Gains Act 1992, shares and securities disposed of need not be the originally acquired holding. In a reconstruction without change of ownership, usually with advance Inland Revenue clearance, or in an exchange of a certain class of shares for another holding under statutorily defined circumstances, the old and new holdings are deemed to be internal changes within a single continuing holding.
Schedule 10 to the Finance Act 2002 does not so much stop and start the clock as make it pause, in the (very limited) cases involving both a close company and the statutorily defined inactivity. The clock pauses when inactivity looms, and resumes when activity is restored, adding further time to the active period already logged. In other words, it does not cancel and reset; it merely hovers. Something dipped in water gets wet. There is no need for a statute to affirm that. It is common sense, and this point is equally basic. If the clock had to be restarted from zero, the Schedule would need to say so, as indeed paragraph 11 of Schedule 1A used to do, in connection with changes of activity - Man of Kent.
Editorial note: Paragraph 11 of Schedule A1 to the Taxation of Chargeable Gains Act 1992 was designed as an anti-avoidance measure to stop 'enveloping', that is the transferring of assets into an existing company and selling the shares, rather than the assets, with the aim of obtaining a higher level of taper relief with regard to the shares than would have been available regarding the asset alone. Unfortunately this section was rather heavy-handed and, as it did not have a 'motive' test, it could catch innocent transactions as well, possibly being less than effective in certain circumstances.
The 'plus side' of paragraph 11 was that its 'change of activity' rules could be used to 'restart' the taper relief clock if the shares would subsequently be treated as business assets. In this way, the full taper relief would be obtained after what was then four years (now reduced to two), rather than suffering from non-business asset 'contamination' for ten years. 'Enveloping' is now seen as less of a problem, due to the reduction in the qualifying period for business assets to two years.
For good and bad, paragraph 11 was abolished by Finance Act 2002 with effect from 17 April 2002 and is now replaced by paragraph 11A. The taper relief clock, which under paragraph 11 could be rewound to, say, 12 o'clock, is now more like a stopwatch whose hands, perhaps appropriately, cease to move during the company's 'periods of inactivity' so that a qualifying period for business asset taper relief does not accrue during that time.
