by Stuart Lightman
Do you know your capital gains “tax group” — or groups? This question is particularly relevant to property companies, which, by reasons of joint ventures, more often have non-100% subsidiaries than do normal commercial or investment companies. Moreover, property groups are more likely to switch property assets from one company to another than commercial groups are likely to switch valuable capital assets.
The Finance Act 1989 included, as one of its targets, the subject of capital gains tax groups. Prior to the Act, such a group consisted of a company and each of its 75% subsidiaries, and their 75% subsidiaries etc. Moreover, the 75% was measured by reference to “ordinary share capital” and it was easy to structure companies so that shares of little commercial value ranked as ordinary share capital — thus enabling artificial groups to be established easily.
Since the Act, only such subsidiaries of a company (referred to as the “principal company of the group”) as are 75% subsidiaries (as originally), but which are also “effective 51% subsidiaries” thereof, are to be included in the principal company’s capital gains tax group. An effective 51% subsidiary is a company in which, if it declared its profits as dividends, 51% of such dividends would percolate through to the principal company; if it were to be wound up (together with all companies which owned its shares, and so on) not less than 51% of its net assets would be paid by way of proceeds on liquidation to the principal company.
Thus not only are artificial capital gains tax groups now ineffective, but companies which one might think to be part of one company’s group might have ceased to be so. For instance, considering a group each company of which has a simple one class structure and each of which is 75% owned by its “parent” as follows:
Hitherto any number of such companies would have formed part of the same capital gains tax group. However, the situation is now as follows. As company B is owned as to 75% by company A it is part of A’s group. As company C is “effectively” owned as to 56.25% (75% x 75%) it is also an effective 51% subsidiary of A. However, company D is owned only as to 42% by company A, and accordingly is not within company A’s group.
A commercial group company which cannot be in one group because of the effective 51% subsidiary rule can, however, be the parent of another CGT group. This therefore applies to company D.
If a company would otherwise be a member of two groups there are rules for determining of which group it is to be treated as a member. This is likely to arise only where, for instance, it is a subsidiary of one company directly, and another company indirectly through one or more third companies.
The first practical result of the legislation is that some companies which were grouped prior to the Finance Act are now likely to have automatically ceased to be so grouped with others, and in any commercial group not consisting wholly or mainly of 100% subsidiaries, there may now be a number of capital gains tax groups. The importance of this topic is that, without a clear understanding (and sometimes even with it) of the result of the new legislation, it will be impossible to tell whether or not any intended intra-group disposal of an asset (ignoring trading stock) will be a tax-free disposal. If it is, then no taxable gain or loss will arise on the transfer, but if it is not, then the disposal will give rise to such a gain or loss just as if the disposal took place to a genuine third party outside the commercial group.
Of course, the subject of ceasing to be a member of a group leads one to think of section 278 of the Income Tax Act 1970, which treats a company ceasing to be a member of a capital gains tax group as disposing of any asset it acquired from a group member while it was a member of such a group. Such disposal would be at the value of the asset when it was received by the company leaving the group.
This problem was foreseen in the legislation which, broadly speaking, disregards for section 278 purposes any such disposal arising solely as a result of the new legislation. It also so disregards any present group company ceasing to be a company as a result of a takeover. At first sight one wonders how a takeover could result in a company ceasing to be a member of the group. However, consider the example given earlier of companies A, B, and C owning respectively 75% of B, C and D and of which A, B and C are grouped for capital gains tax purposes. If, however, a new company (company Z) were to acquire 75% of company A, then it would become the principal Company of the group, which would now comprise Z, A and B, and company C would have ceased to be a member. Companies C and D would now constitute a group by themselves.
There are also provisions which, for the purposes of such rules, treat as shareholders certain loan creditors in respect of “non-commercial loans”. These are loans that give the loan creditor an interest in the company which is akin to equity capital. For instance, loans which are convertible into shares, and loans which entitle the loan creditor to any amount of interest that depends on the extent or results of the company’s business or any part of it, or the value of any of the company’s assets; or loans made on terms which exceed a reasonable return for the consideration lent by the creditor.
Moreover, the existence of such a loan may (for reasons which are beyond the scope of this article) involve it not being known until the end of the year, or the extent of the loan creditor’s notional equity interest in the company, so that any transfer made during the year, to or from the particular company, may be one where it is not known at that stage whether or not that transfer was intra-group.
This article does little more than introduce the subject. The Finance Act (which was the biggest on record) devotes a substantial space to groups generally, but this is in a sense the most urgent, as in groups (other than 100% or thereabouts and with no unusual share structures) it needs to be fully understood before it is safe to move any investment property from one company in the group to another.
