In Part One, we saw how the degrouping rules prevent capital assets from leaving a group tax free within a corporate wrapper. This article finishes off with a few miscellaneous, but important points concerning the operation of these rules.
All intra-group transactions are tax neutral, as they take place within the same economic unit. When a company leaves a group, still holding an asset acquired from a fellow group member, a degrouping charge arises if the acquisition took place within the previous 6 years. This degrouping charge - which may be a loss - is intended to revoke the tax neutral status of the original transaction.
We saw last time that the degrouping charge is calculated by pretending that the exiting company ("Company A") sold and bought back the asset immediately after having acquired it from its fellow group member. The consequence of this notional transaction is that the tax burden lies in the first place on A. However, if A is leaving the group by means of a share sale, it is the seller that bears the burden.
This brings us to the first point of note.
This is actually quite a powerful statement. When the degrouping takes place as a result of a share sale, the degrouping charge is transferred from the company leaving the group, to the group member selling the shares.
However, it is not simply a case of transferring liability from one company to another. In the envelope scheme, Newco is deemed to have sold the property on leaving the group, but V's liability is deemed to arise on its shareholding in Newco itself. This is a direct consequence of adding the degrouping charge to the purchase price in V's capital gains computation1.
What would be the position if the Newco shares qualify for a tax exemption? In these circumstances the degrouping charge on the property is actually extinguished. This is the result of transferring the taxable gain on the property to the exempt gain on the shares. And yet a direct property sale would have been fully taxed! We shall discuss this concept in more detail in a later article.
This transformation is only possible when the company leaves the group by means of a share disposal - for example, when the company is sold. But an exit is also possible by the sale of a company further up the group chain. For example in the diagram below, A has left the group on the sale of its immediate parent C.
This time, the degrouping charge is added on to the sale price for C, not A - A is not being sold. Note that C doesn't actually own the asset itself. Furthermore, one doesn't need to sell the entire company. For example, a holding of 100% can be diluted by selling more than 25% of the share capital.
The next diagram shows how a company can leave a group without a share disposal.
Company A, is a wholly owned subsidiary of V holding 100 shares. It is intended that P will obtain a 90% stake in this company. This can be achieved in two ways:
In either case, A leaves the group, as V's stake is diluted to 10%.
We have seen that on a share sale, it is V, the seller who bears the degrouping charge. But if there is no share sale - as is the case where the shares are issued - the degrouping charge remains with the asset, and is primarily borne by A.
There is however, a caveat. If the value shifting rules apply when A issues the shares, the dilution of V's shareholding is deemed to be a partial sale2. According to HMRC, this would mean that A has left the group by means of a share disposal after all3.
It is not entirely clear to me why this should be the case.
The words of the legislation state that the purchase price adjustment is made "if company A ceases to be a member of the group in consequence of" a share disposal(s.)4. This phrase gives the impression of cause and effect - company A leaves the group because shares have been disposed of. But in the above situation, this is not what has happened. It is the issuing of the shares to P that has caused A to leave the group, not the deemed share sale from V to P5.
So far, we have shown that the degrouping charge falls either on the company leaving the group, or the company that sells the shares resulting in the degrouping. However, it is possible to allocate the degrouping charge to other group members6.
This is a useful option if these other members have losses or gains of their own, that can be set off against the degrouping charge, and therefore lower the group's overall tax burden.
To summarise the main points arising from Part One and Part Two:
In our next article we shall discuss the IP degrouping rules. We shall see the treatment of IP is similar to that applying to capital assets, but with some important differences.
(This article is Part Two of a two part mini-series on the Capital Gains Degrouping Rules. Both parts can be read in a single article in pdf format which can be downloaded at Academia.edu.)
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
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