Should a company pay corporation tax on gains made on selling shares? If it does, there could be double taxation when the gain is distributed out of the company or the company is wound up. If it does not, the company could make huge profits and not pay any tax on them.
The substantial shareholdings exemption (SSE) was introduced in 2002 as a half-way house solution to this conundrum. Gains made by companies on the sale of shares were made exempt provided they had held at least 10% of the ordinary shares for a continuous period of 12 months in the two years leading up to the sale. Amongst other things, this enabled UK groups to dispose of subsidiaries without triggering a corporation tax liability (provided the conditions for the exemption were satisfied).
Part of the logic for introducing the exemption was to make the UK an attractive country in which to locate an international holding company. Few would choose to hold their subsidiaries via a UK company if the UK charged tax on selling the subsidiaries. However, the SSE was very restrictive compared to the regimes of popular European holding company jurisdictions such as the Netherlands and Luxembourg, and so the complexity of the SSE in fact became one of the reasons for not locating holding companies in the UK.
The Government has duly acted (albeit 15 years later) to remove the most significant restriction. The 2002 SSE rules required that:
- the company being sold was a trading company (or the holding company of a trading group) both before and after the sale; and
- the seller itself was, likewise, a trading company (or the holding company of a trading group) both before and after the sale.
For this purpose a trading company (or the holding company of a trading group) could not have substantial non-trading activities and HMRC took this to mean that no more than 20% of its activities could be non-trading.
This second requirement always seemed somewhat arbitrary – if a holding company is to be given an exemption for selling its trading subsidiaries why should it only apply if it retains other trading subsidiaries after the sale? The requirement was often very difficult to satisfy. If one had, for example, a group consisting of a holding company with eight wholly trading subsidiaries and two wholly non-trading subsidiaries, all identically-sized, the exemption would probably not apply to the sale of any of the subsidiaries – if one of the trading subsidiaries was sold, at best 7/9ths (78%) of the remaining activities of the group would consist of trading activities and this would mean that the seller failed HMRC’s 20% non-trading test after the sale.
From 1 April 2017 the requirement that the selling company is a trading company (or the holding company of a trading group) is entirely abolished. So in the above example, the SSE would apply to the sales of all eight trading subsidiaries. This is a significant simplification of the rules and boosts the argument that the UK is, after all, a good international holding company location. The change will also be of great interest to domestic UK groups. (The simplification also has the by-product of removing paragraph 3(3) of Schedule 7AC of the Taxation of Chargeable Gains Act 1992 from the statute book, which concerned an extension to SSE relief and was arguably the most confusing provision ever written.)
Also from 1 April 2017 the first requirement above will be relaxed. The company being sold still needs to be a trading company (or the holding company of a trading group) before the sale, but it only needs to be one after the sale if the sale is to a connected party. This is unlikely to have a significant effect in practice.
Another relaxation of the SSE rules is that, again from 1 April, the requirement that the seller holds at least 10% of the ordinary shares of the company for a continuous period of 12 months in the two years leading up to the sale is changed to a requirement that this condition is satisfied in the six years leading up to the sale. That is, if the seller owns less than 10% of the ordinary shares on the date of sale, but owned 10% or more at some point in the last six years for a continuous period of 12 months, the exemption will apply.
In addition to these changes, a new SSE is being introduced for companies owned by tax exempt vehicles such as registered pension schemes and overseas equivalents, companies carrying on life assurance business, sovereign wealth funds, charities, investment trusts, UK authorised investment funds and UK exempt unauthorised unit trusts (qualifying institutional investors or QIIs). QIIs effectively lose their tax exemption if they invest in a holding company which makes a gain on selling shares in circumstances where the SSE is not available (say because the sale is of shares in a non-trading company).
Accordingly, a new SSE will apply to disposals from 1 April 2017 under which the requirement that the company being sold is a trading company (or the holding company of a trading group) is absent. The new SSE applies to exempt the gain from tax entirely where more than 80% of the share capital of the selling company is owned by QIIs, and to exempt a proportion of the gain from tax where more than 25% but less than 80% of the share capital of the investor is held by QIIs. The new SSE will apply not only to holdings of 10% or more but also generally to shareholdings of less than 10% where the cost of acquisition of the shareholding was at least £50 million.
These changes make the UK a better place in which to locate an international holding company. This is useful at a time when Brexit may give international groups reasons not to choose to stay in, or come to, the UK.
This article is based on the draft Finance Bill published on 5 December 2016. The legislation could change before its enactment.