The degrouping charge: anti-avoidance rule for the sub-group exception
Before FA1995 it was possible for companies to exploit the exclusion from the degrouping charge for associated companies leaving a group at the same time so that they could, in effect, re-create the `envelope trick’, see CG45400. The following example illustrates this.
Stage 1: the group headed by company S wishes to dispose of its interest in asset x without incurring a chargeable gain. Asset x is held by S’s subsidiary T, which acquired the asset from an unconnected third party. Company T transfers asset x to its subsidiary U in consideration for an issue of shares.
U acquires asset x at no gain/no loss under TCGA92/S171(1). T acquires the shares in U at a capital gains cost reflecting the market value of asset x.
Stage 2 T ceases to be a member of the capital gains group headed by S as a result of either the 75 per cent subsidiary or the effective 51 per cent subsidiary relationship between S and T being broken, see CG45160+. For example, a third party might subscribe for sufficient ordinary share capital in T, with minimal economic rights, to break the 75 per cent link between S and T. This would cause T and U to leave the S group even though in economic terms the position is virtually unchanged.
There is no degrouping charge on U at the time it ceases to be a member of the S group because T and U are associated companies which leave the group at the same time and transfers between the two are ignored for the purposes of the degrouping charge. T is now itself the principal company of a group comprising companies T and U.
Stage 3 T sells U to an unconnected third party, but does not realise a chargeable gain because the capital gains cost of the shares in U reflects the market value of the underlying asset x.
There is no degrouping charge on U at the time it leaves the group headed by T. This is because U does not own an asset acquired in the previous six years from another company which was at the time of acquisition a member of `that group of companies’ (that is the group headed by T) as TCGA92/S179 (1) requires. U acquired asset x from T when they were members of the S group.
TCGA92/S179 (2A), TCGA92/S179 (2B) & TCGA92/S179 (9A)
FA95/S49 introduced TCGA92/S179 (2A), (2B) and (9A), which prevent exploitation of the associated companies exclusion from the degrouping charge. The legislation only applies where there is a connection between the two groups involved, see below. In terms of the example above, the legislation works by treating the acquisition of asset x by U as if it had taken place at a time when T and U were both members of the T group for the purposes of TCGA92/S179 (1). This means that the conditions for the degrouping charge to operate on the departure of U from the T group are now satisfied.
The legislation introduced by FA1995 has effect where a company ceases to be a member of the second group on or after 29 November 1994. The legislation was amended in Finance Act 2011 for companies ceasing to be a member of the first group on or after 23 March 2011. The changes made were:
- To introduce an additional “trigger” condition,
- To allow the possibility of TCGA92/S179(2) to effectively switch off the rule where there is no tax avoidance,
- To generally re-cast the way the rule is set out.
TCGA92/S179 (2A), (2AA) and (2AB)
The rule operates in the following circumstances
- Company A ceases to be a member of a group of companies (the first group) having acquired an asset from company B when they were members of that group, TCGA92/S179(2A)(a) and (aa) (before Finance Act 2011: TCGA02/179(2A)(a)) and
- TCGA92/S179(2) applies in respect of that acquisition when company A leaves the first group, TCGA92/S179(2A)(b), and
- Company A joins a second group at that time which is connected with the first group, TCGA92/S179(2A)(c), (previously TCGA92/S179(2A)(d)), and
* Company A later ceases to be a member of the second group (TCGA92/S179(2A)(d)(i) (previously TCGA92/S179(2A)(c), or * There ceases to be a connection between the two groups, TCGA92/S179(2A)(d)(ii). This applies only where a company left the first group on or after 23 March 2011.
The effect of the rule being triggered is that TCGA92/S179(1) applies at the time company A leaves the second group as if the asset had been acquired when both companies were members of the second group. In other words, taking the example above, there would be a degrouping charge on U at the time it leaves the group headed by T, TCGA92/S179(2AA)(b) (previously TCGA92/S179(2A)).
The operation of this rule when the first and second group cease to be connected is accommodated by treating company A and any associated company as having left the second group at the time if that event, TCGA92/S179(2AA)(a).
HMRC’s interpretation of this provision until the Finance Act 2011 changes is that where TCGA92/S179(2A) applies then the further operation of the associated companies exemption in TCGA92/S179(2) is not considered. That is, a degrouping charge is triggered in a situation where Company A and Company B also leave the second group as associated companies.
The changes in Finance Act 2011 also introduced a second trigger: where the groups cease to be connected. Because some forms of commercial demerger will necessarily involve the creation of a second group under the same control, the revised legislation will allow the associated companies exemption to apply again unless the associated companies left the first group as part of arrangements with a main purpose of avoiding liability to corporation tax. TCGA92/S179(2AA)(c) and (2AB). Where the arrangements are the subject of a statutory clearance then the decision of the Clearance & Counteraction Team on that matter will also apply for TCGA92/S179(2AB) in respect of the purpose of the proposed transactions.
TCGA92/S179 (2A) only applies in situations where there is a connection between the first and second groups. TCGA92/S179(2B) contains the rules for establishing whether a connection exists for these purposes. This involves looking at who controls the principal company of the second group when the chargeable company leaves that group.
Two groups are connected if the principal company of the second group is under the control of any person or persons as set out in (a), (b) or (c) below
- the company which is the principal company of the first group
if the first group no longer exists, the company which was the principal company of the first group when the chargeable company left it
- any person or persons who control the company referred to in (a), or who have had that company under their control at any time since the chargeable company ceased to be a member of the first group (see note below)
- any person or persons who have, at any time in the period since the chargeable company ceased to be a member of the first group, had under their control
a company which would have been a person within (b) above if it had continued to exist
a company which would have been a person within this condition (c) (see note below).
For the purposes of TCGA92/S179 (2B) the definition of `control’ is that in CTA10/S450-451. A bank is not taken to have control of a company for these purposes by reason only of rights attaching to a loan which it made to that company in the ordinary course of its banking business.