Company reconstructions and sales

Company reconstructions and sales

Introduction
The rules relating to exchanges of shares which qualify for Entrepreneurs's relief with other shares or securities are complex and have changed a number of time since the introduction of the relief. It is therefore essential to know both the date on which the exchange took place and the character of the share or security which was acquired

Exchange of shares for shares or securities other than QCBs
Where shares or securities are replaced, in whole or in part, by other shares or securities in the course of a reorganisation of share capital, a takeover by way of a “paper for paper” exchange or a company reconstruction then, subject to certain conditions, the transactions are not treated as a disposal of the original shares and securities or an acquisition of the new shares or securities received. Instead the original shares or debentures and the new holding following the transactions are treated as the same asset acquired as the original shares were acquired.

In such cases, it is possible that the disposal of the original shares at the time of the reorganisation, exchange or reconstruction would result in a gain that could qualify for entrepreneurs' relief, whereas the gain on the later disposal of the new holding may not qualify, for example because the company may no longer be the individual's personal company following the reorganisation, exchange or reconstruction.

Therefore, where there is a reorganisation within the meaning of TCGA 1992 s 126 (including an exchange of shares or securities which is treated as a reorganisation by virtue of ss 135, 136) and the original shares and the new holding, within the meaning of that section, would fall to be treated as the same asset by virtue of TCGA 1992 s 127, an election can be made to claim entrepreneurs' relief as if the reorganisation involved a disposal of the original shares and that s 127 does not apply. This would have the effect of crystallising the gain for the tax year in which the exchange takes place. If no election is made the gain will be deferred until the redemption or disposal of the shares or securities taken in exchange. If the reorganisation would, apart from s 127, involve a disposal of trust business assets, the election must be made jointly by the trustees and the qualifying beneficiary. In all other cases it must be made by the individual4. The time limit for the election is the first anniversary of 31 January following the tax year in which the reorganisation takes place

HMRC give the following example—

Example

In August 2009 Miss K exchanges her shares in the trading company X Ltd for shares issued by a new company, H plc. For some years she has been an employee of X Ltd, owning 40% of the ordinary shares, which entitle her to exercise 40% of the votes in the company. She therefore meets the conditions for claiming entrepreneurs' relief in respect of her shares in X Ltd. But in the exchange she receives shares amounting to only 2% of the ordinary shares of H plc. This is below the minimum 5% holding requirement, so Miss K will not be able to qualify for entrepreneurs' relief on a disposal of her new shares in H plc.

Under the normal rules for share exchanges Miss K would be treated as making no disposal of her shares in X Ltd at the time of the exchange in August 2009 and there is no immediate charge to CGT then. These rules would therefore mean she loses all possibility of claiming entrepreneurs' relief. In order to allow a claim to the relief she can elect to disapply those normal rules. Disapplying the rules means she is treated as disposing of the shares in X Ltd at the time of the exchange in August 2009. She can then claim entrepreneurs' relief on the gain arising on that disposal.

General
Where there is an exchange of shares or securities for qualifying corporate bonds (QCBs) no chargeable gain arises at the time of the exchange A calculation is made of the gain that would have arisen if the exchange (the relevant transaction) had involved the disposal of the shares or securities (the old asset) at their market value at the time. This gain is deferred and comes into charge when the QCBs (the new asset) are redeemed or otherwise disposed of. If only some of the QCBs are redeemed or disposed of a proportionate part of the deferred gain is chargeable at that time.

Exchanges prior to 23 June 2010
For exchanges prior to 23 June 2010, it was possible to claim entrepreneurs' relief when calculating the gain that would have arisen at the time of exchange. Therefore, where TCGA 1992 s 116(10)(a) applied to produce a chargeable gain for an individual as a result of a relevant transaction, entrepreneurs' relief had effect as if the relevant transaction were a disposal of business assets consisting of the old asset

Where the disposal of the old asset was a material disposal of business assets and entrepreneurs' relief was claimed in respect of it, the s 169N(1) gain was the amount calculated under s 116(10)(a), and was then reduced by 4/9, (subject to the applicable unused lifetime limit). On a subsequent disposal of the whole or part of the new asset, the whole or a corresponding part of the gain, as reduced by entrepreneurs' relief, was treated as arising under s 116(10)(b)

Effectively, section 169R as previously enacted allowed the “deferred” gain on the exchange of shares for QCBs to be both 4/9 discounted by entrepreneurs' relief, and deferred until the disposal of the QCBs.

Exchanges on or after 23 June 2010
A gain must be brought into account immediately for the relief to apply, by electing out of s 116(10) treatment. The election must be made on or before the first anniversary of the 31 January following the tax year in which the transaction takes place

New asset, old asset and relevant transaction have the meanings given in TCGA 1992 s 116 (see D6.110)

HMRC have provided a number of examples (relevant to pre 23 June 2010 disposals) including the following Example 7. See Example 2 for how the rules take effect for relevant disposals on or after 23 June 2010.

Example 1

A exchanges her shares in the trading company Y Ltd for qualifying corporate bonds (QCBs) on 1 June 2010. For some years she has been an employee of Y Ltd, owning 10% of the ordinary shares, which entitle her to exercise 10% of the votes in the company.

She therefore meets the conditions for claiming entrepreneurs' relief in respect of her shares in Y Ltd. The normal rules for share exchanges apply so there is no immediate charge to CGT in 2010 when she exchanges the shares, but the gain that would have arisen on a disposal of those shares for full market value at the date of the exchange is calculated. That calculation results in a gain of £63,000.

A's gain of £63,000 will become chargeable to CGT when the QCBs are redeemed or she disposes of them in any other way. Assuming A claims entrepreneurs' relief in respect of the £63,000 gain it will be reduced by 4/9 to £35,000 and that will be the amount that becomes chargeable when she disposes of the QCBs.

Example 2

On 24 June 2010, Tabor sells the entire share capital in his trading company consisting of 3,000,000 ordinary shares to X Ltd, realising a £3,000,000 gain. He receives £2,000,000 in cash and £1,000,000 in QCBs. Tabor claims entrepreneurs' relief on the £2,000,000 gain arising from cash disposal of 2,000,000 shares.

The £1,000,000 gain arising from exchange of the remaining 1,000,000 shares for QCBs would under normal circumstances be deferred under TCGA 1992 s 116 until the disposal of the QCBs. Tabor can no longer allow the gain to be held over, and make a claim for entrepreneurs' relief to reduce that held-over gain.

He must either make an election to disapply section 116, and trigger an immediate gain on which he will pay tax at 10%, or pay tax on the £1,000,000 gain at the applicable rate at the time of disposal of the QCBs. Entrepreneurs' relief will not be available in respect of the disposal of the QCBs.

Gains held over under section 116 on security exchanges prior to 6 April 2008
Transitional provisions apply where a chargeable gain is deemed to accrue by virtue of TCGA 1992 s 116(10)(b) on a disposal made on or after 6 April 2008 in relation to a relevant transaction occurring before that date8. Where there is an exchange of shares or securities for QCBs (the relevant transaction) before 6 April 2008 and a deferred gain relating to the exchange becomes chargeable on an individual who was a party to the exchange on or after 6 April 2008 (a relevant disposal) entrepreneurs' relief may be claimed in respect of the gain coming into charge if the gain on the disposal of the old asset would have qualified for the relief, had it been available at that time9. The time limit for making the claim runs from the date of the “first relevant disposal”, being the first disposal made on or after 6 April 2008 on which a chargeable gain is deemed to accrue to the individual by reason of the relevant transaction10. Relief is only available to the individual who made the exchange. If all or part of the new asset has been transferred to a spouse or civil partner and, as a result, all or part of the deferred gain subsequently arises to that person, entrepreneurs' relief will not be available in respect of that part of the gain11.

first relevant disposals prior to 23 June 2010
the amount of the gains deferred as a result of the relevant transaction which have not come into charge before 6 April 2008 constitutes the section 169N(1) gain (see C3.1307) subject to relevant applicable lifetime limit. This resulting amount is reduced by 4/9 and the amount so calculated is the amount of the chargeable gain deemed to accrue under section 116(10)(b)12.

For first relevant disposals on or after 23 June 2010
the amount of the section 116(10)(b) gain (the held-over gain, which is deemed to be a chargeable gain arising to the taxpayer on disposal of the QCB) is reduced by the amount of any gains that have been deemed to accrue prior to 6 April 2008 as a result of the relevant transaction13.

This aggregate amount is then treated as the section 169N(1) amount, and the sections 169N(3)–(4B) are applied to the deemed chargeable gain accordingly14. The appropriate part of the held-over gain which is deemed to arise on disposal of the QCB is therefore charged to capital gains tax at 10 per cent where a successful claim for entrepreneurs' relief is made.

Gains held over under section 116 on security exchanges between 6 April 2008 and 22 June 2010
Where the first relevant disposal is also prior to 23 June 2010, the amount of the gains deferred as a result of the relevant transaction which did not come into charge constitutes the section 169N(1) gain (see C3.1307) subject to relevant applicable lifetime limit. This resulting amount is reduced by 4/9 and the amount so calculated is the amount of the chargeable gain deemed to accrue under section 116(10)(b) as above.

Where first relevant disposal is on or after 23 June 2010, the amount of the gain deferred is still the post entrepreneurs' relief amount in line with section 169R in force at the time of exchange (ie after the 4/9 reduction), but the appropriate rate of CGT will be 18 per cent or 28 per cent, producing an effective rate of 10 per cent or 15.56 per cent respectively15.

Part disposals of the QCB holding
For both pre and post 22 June 2010 first relevant transactions, where the whole of the new asset is not disposed of at the time of the first relevant disposal, only an appropriate proportion of the gain deemed to accrue under section 116(10)(b), as calculated above, is chargeable. The “appropriate proportion” is the proportion of the new asset, or so much of it as was not disposed of before 6 April 2008, which is disposed of on the relevant disposal16. For example, if the first relevant disposal is of one third of the QCBs held at that time, one third of the net gain deemed to accrue under section 116(10)(b), as calculated above, comes into charge on that occasion. A further proportion of the net gain will come into charge on later relevant disposals by the individual, pro rata to the proportion of QCBs disposed of in each disposal