HM Treasury has published its consultation document on the potential reform of the substantial shareholding exemption (SSE). The consultation is broad, largely driven by the desire to make the UK a more competitive holding company jurisdiction, but it also gives a nod to simplification and coherence. Comments are invited by 18 August 2016 and a response can be expected in the Autumn Statement. Any resulting draft legislation should be included in Finance Bill 2017.

The consultation paper divides into four parts drivers for change, options for reform, the treatment of funds and more detailed issues that may also be addressed.

DRIVERS FOR CHANGE

The key area of focus is improving the UK's ability to compete internationally as a holding company jurisdiction of choice. HM Treasury is conscious that other jurisdictions have broader participation exemptions. It is keen to draw up an "evidence base" of situations where the SSE has influenced holding company locations to assess the likely benefits to the exchequer of substantive reform.

OPTIONS FOR REFORM

HM Treasury has identified five main ways in which it may reform the SSE legislation to achieve the aims mentioned above. These are summarised, and our initial comments are noted, in the boxes on page two. Some of the options could be combined so, (for example) a broader definition of "substantial shareholding" could be used and the investor trading tests could be dropped.

TREATMENT OF FUNDS

The reform could extend the benefit of the SSE to funds, including sovereign wealth funds and pension funds (which would benefit from exemptions if they held investments directly in any case) and potentially certain types of widely held private equity funds.

DETAILED CHANGES

The consultation paper identifies a number of more specific technical issues that currently (unintentionally) narrow the scope of the SSE. Additional changes may be made to the legislation to resolve these points.

The issues that have been identified are:

  • the inability to trace SSE groups / sub-groups through partnerships;
  • the treatment of companies limited by guarantee and overseas entities such as US limited liability companies, that do not (necessarily) have "ordinary share capital";
  • companies losing the benefit of the SSE where the sale of a rump shareholding of less than 10 per cent is delayed beyond the two year period for reasons beyond the investing company's control. The paper suggests extending the period to six years; and
  • satisfying the trading conditions "immediately after" the relevant disposal is difficult where there is a gap between receipt of consideration and its reinvestment; or where there is a liquidation.

All of the above suggestions are good news for simplification and effectiveness of the SSE. However, the issues noted above are just a few of a number of traps for the unwary currently in the legislation, and the solutions may be more complicated than HM Treasury currently appreciates. For example, the issues relating to partnerships and companies without ordinary share capital apply equally and more generally to chargeable gains groups, so both should be considered together. That could cause inadvertent degroupings so transitional rules are likely to be needed for a smooth change.

ALL COMMENTS WELCOME

The consultation document makes it clear that comments on the above matters, and any other aspects of the SSE legislation, are welcome. If your business qualifies (or in your view should qualify) for the SSE, the paper is well worth reading.

MAIN OPTIONS FOR REFORM

OPTION ONE: COMPREHENSIVE EXEMPTION

Key features

Broader exemption and fewer conditions

Benefits

Strongly enhances the UK's ability to compete with other jurisdictions' participation exemptions

Government concerns

  • Potential to exempt more transactions than the policy intends, including trading disposals and gains resulting from untaxed income
  • Potential to encourage avoidance behaviour, (e.g. enveloping passive assets (land, intellectual property assets) and creating allowable losses)

Likelihood of implementation

Low

OPTION THREE: NEW INVESTEE TEST

Key features

  • Retain conditions on nature / activities of investee company but expand to cover active / actively managed businesses
  • Remove trading conditions for investor company

Benefits

  • Simplification
  • Less uncertainty for multinational groups on entity classification / ordinary share capital analysis and on changes to group structure over time (though still relevant to investees)
  • Broadens scope of SSE to cover actively managed businesses (not just traders)
  • Reduces need for clearances

Likelihood of implementation

Medium

OPTION TWO: INVESTEE TRADING TEST

Key features

  • Retain conditions on nature or activities of investee company
  • Remove trading conditions for investor company

Benefits

  • Simplification
  • Less uncertainty for multinational groups on entity classification / ordinary share capital analysis and on changes to group structure over time (though still relevant to investees)
  • Broadens scope of SSE to cover actively managed businesses (not just traders)
  • Reduces need for clearances

Likelihood of implementation

Medium

OPTION FOUR: AMENDED INVESTOR AND INVESTEE TRADING TESTS

Key features

  • Retain conditions on nature / activities of investee and investor companies (possibly incorporating expansion to "businesses" as per Option Three)
  • Focus on entities involved in the transaction rather than wider groups

Benefits

  • More focused on UK entities involved
  • Less uncertainty for multinational groups on entity classification / ordinary share capital analysis and on changes to group structure over time (though still relevant to entities involved in the transaction)
  • May enable some simplification

Likelihood of implementation

Medium

OPTION FIVE: NEW "SUBSTANTIAL SHAREHOLDING" DEFINITION

Key features

  • Lower shareholding threshold / alternative type of threshold (e.g. a minimum investment amount)

Benefits

  • More consistent treatment of significant investments that do not necessarily create 10 per cent stakes (e.g. infrastructure projects)
  • More flexibility for staggered disposals, (e.g. where ratchet share rights / options exist)

Likelihood of implementation

Low to medium