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HMRC internal manual

Capital Gains Manual

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HM Revenue & Customs
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Depreciatory intra-group dividends: drain out dividend scheme

TCGA92/S31

The value shifting rules in TCGA92/S31 were introduced in response to an avoidance device known as the drain out dividend scheme. To understand the structure of these rules it is necessary to understand how the drain out dividend scheme was intended to work. The following example illustrates the scheme.

Example

This example ignores indexation.

The initial situation is that in year 1 group parent company P subscribes £20M for shares in a newly incorporated 100 per cent subsidiary Q. Company Q acquires an asset for £20M from an unconnected third party. In year 5 the asset, which is now worth £70M, is to be sold to an unconnected third party. P wishes to avoid any tax charge on the latent gain £50M and enters into the drain out dividend scheme.

Stage 1

Q acquires a newly incorporated 100 per cent subsidiary R. Company R borrows £70M and buys the valuable asset from Q at its market value £70M. This sale is at no gain/no loss for capital gains purposes. But in commercial terms Q has made a profit £50M which is available for distribution. Q pays the £50M as a dividend to P. The dividend is not chargeable in the hands of P because of ICTA88/S208, and there are no ACT consequences because a ICTA88/S247 election is in force.

Stage 2

The value of P’s shares in Q is now £20M. Q’s assets are cash £20M and its shares in R, but the value of Q’s shares in R is negligible. This is because the value of the asset acquired by R from Q is matched by an equivalent borrowing at Stage 1. P can now sell the shares in Q to the third party purchaser at market value £20M. There is no degrouping charge on the asset held by R since R acquired the asset from Q, and both Q and R leave the P group at the same time, see CG45455+.

P has thus received £70M in respect of its shares in Q: £20M from the third party purchaser and £50M as a dividend from Q. But the scheme seeks to avoid any capital gains charge on the profit £50M. Although the third party purchaser has only paid £20M for Q, the purchaser can inject additional equity £50M into Q which Q can lend to R to pay off part of the loan incurred at Stage 1. On any subsequent sale of Q the purchaser can therefore obtain a capital gains deduction for the full value of Q before it was stripped.

Finance Act 2011 introduced a new Targeted Anti-Avoidance Rule for disposals of shares and securities by companies on or after 19 July 2011. See CG48500+.