There has been some excitement recently in relation to changes to the capital gains degrouping charge rules which are due to take effect in July (although in certain circumstances they will apply from April 2011).

Background

Where assets are transferred between companies in the same corporate group, this is treated for capital gains purposes as being for such a consideration as ensures that neither a gain nor a loss arises in the transferring company. However, at present, where a company leaves a group holding an asset that was acquired from another company in the group within the previous six years, the company leaving the group is treated as if, immediately after it acquired the asset, it had sold and immediately reacquired the asset at market value. This can create a significant tax charge (referred to as a "degrouping charge") in the company leaving the group. It is intended to crystallise any latent capital gain that was not charged to tax when the asset was transferred intra-group.

Where a company is acquired from a corporate group, the purchaser will normally want to ensure that no such charges will arise in the target company, or that they will be covered by the tax covenant in the SPA.

The changes

The Finance Bill 2011 will amend the rules from the date of Royal Assent, which is expected in July (although in certain circumstances companies are able to elect for the new rules to apply from 1 April 2011). Under the new rules, the degrouping charge will normally no longer arise in the company leaving the group, but will instead take effect as an adjustment to the gain or loss made by the seller on the sale of the shares in the target (so that if a gain would have arisen in the company leaving the group, then the seller will make a bigger gain (or smaller loss) on the sale of those shares). It should be noted that the new rules may not apply where none of the sellers is within the charge to UK tax.

Comment

This is regarded as a positive change by business, in particular because it means that reliefs or exemptions (such as the substantial shareholdings exemption) that apply to a gain made on the sale of shares by the seller will also apply to the degrouping charge. In addition, companies may now make a claim to HMRC to reduce a degrouping charge (whether arising in the company leaving the group or taking effect as an adjustment to the seller's gain or loss) where it would be "just and reasonable" to do so. This is intended to reduce the economic double taxation that can sometimes occur as a result of degrouping charges (because the gain reflected in the degrouping charge may already be reflected in the gain arising on the share sale).

The changes should also be advantageous for purchasers of companies, because degrouping charges should not normally arise in target companies, and so tax covenant protection should no longer be required for this. However, a purchaser will still need to know whether the seller has made a claim for a "just and reasonable" reduction to its gain on the share sale, because this could affect the tax position of the target company going forward, and so this will need to be covered off in the tax warranties.