Policy paper

Statement of Practice 5 (2002)

Published 6 April 2002

Statement of Practice 5 (2002)

Introduction

The regime in schedule 7AC TCGA 1992 (‘schedule 7AC’) for the exemption of gains on disposals of substantial shareholdings will apply to disposals of shares (or an interest in, or an asset related to shares) by companies which have held a substantial shareholding for at least 12 months where:

• the company holding the shares (or an interest in, or an asset related to shares) is a trading company or a member of a trading group, and
• the shares in question are shares in a trading company or the holding company of a trading group or subgroup

The exemptions provided by the regime may create opportunities for manipulation. The provisions therefore contain an anti-avoidance rule at paragraph 5 of schedule 7AC. This is aimed at tax-driven arrangements which are intended to exploit any of the exemptions.

We expect cases where the anti-avoidance rule is in point to be unusual and infrequent.

In what follows, references to paragraphs are to paragraphs of schedule 7AC.

Outline of the anti-avoidance rule

Paragraph 5 is aimed at ‘arrangements’ from which the ‘sole or main benefit’ that can be expected to be derived is that a gain on a disposal will be exempt by virtue of an exemption in Part 1 of schedule 7AC. The remedy is to deny exemption on any gain arising on the relevant disposal. ‘Arrangements’ is defined widely and includes ‘any scheme, agreement or understanding, whether or not legally enforceable’.

Paragraph 5(1) provides that certain events must occur in pursuance of the arrangements before the ‘sole or main benefit test’ in paragraph 5(2) can apply, an untaxed gain must accrue to a company (‘company A’) on a disposal of shares, or an interest in shares or an asset related to shares, in another company (‘company B’)

and before the gain accrued either:

• company A acquired control of company B, or the same person or persons acquired control of both companies, or
• there was a significant change of trading activities affecting company B at a time when it was controlled by company A, or when both companies were controlled by the same person or persons

Paragraph 5(5) provides that there is a ‘significant change of trading activities affecting company B’ if:

• there is a major change in the nature or conduct of a trade carried on by company B or a 51% subsidiary of company B, or
• there is a major change in the scale of the activities of a trade carried on by company B or a 51% subsidiary of company B, or
• company B or a subsidiary of company B begins to carry on a trade

A ‘major change in the nature or conduct of the trade’ in this legislation has the same meaning as in S768 ICTA 1988.

For the purposes of paragraph 5(1) a gain is ‘untaxed’ if the gain, or all of it but a part that is not substantial, represents profits that have not been brought into account (in the UK or elsewhere) for the purposes of tax on profits for a period ending on or before the date of the disposal. ‘Profits’ for these purposes means income or gains, including unrealised income or gains. But profits are not ‘untaxed profits’ if an amount in respect of these profits is apportioned to and chargeable on a UK-resident company under the controlled foreign company rules for an accounting period of the company ending on or before the date of the disposal.

Application of the rule

It will be a question of fact in any particular case as to whether a gain wholly, or wholly except for a part which is not substantial, represents untaxed profits. Broadly, this will involve looking at how the consideration obtained for the shares is derived from assets held directly or indirectly by company B.

It will usually be obvious when profits are ‘untaxed’ within the meaning of paragraph 5. For example, unrealised profits on capital assets will be untaxed profits. It is impossible to provide a comprehensive catalogue of all situations where the gain will represent untaxed profits but some examples of situations where the profits will not be untaxed profits for the purpose of paragraph 5 would be:

• a dividend received by a holding company that is paid out of taxed profits of the subsidiary
• where the profits in question themselves represent an exempt gain on disposal of a substantial shareholding
• where no tax is payable on profits because they are covered by a specific relief (eg, loss relief)

In many cases a gain will represent both taxed and untaxed profits. In these circumstances, the gain should be taken as first representing the taxed profits and only any balance which then remains as representing untaxed profits.

In the context of this legislation we interpret ‘substantial’ as meaning more than 20%.

Even if on this basis the gain wholly, or wholly except for a part which is not substantial, represents untaxed profits, the exemption would be denied only if:

• each of the circumstances set out in paragraph 5(1) occurs in pursuance of arrangements, and
• the sole or main benefit that could be expected to arise from the arrangements is that the gain accruing on the disposal would otherwise be exempt under schedule 7AC, and
• from the outset the sole or main benefit expected to arise from the arrangements is the achievement of that outcome