CG51820 - Shares and securities: share reorganisations: consideration paid
As a reorganisation is treated as not involving the acquisition of any new shares aspecial rule is required for dealing with any consideration actually paid for the new holding. TCGA92/S128 (1) provides any consideration which is given for the new holding is deemed to have been incurred on the original shares. This is most relevant to rights issues.
TCGA92/S128 (2)
Consideration will normally be given in the form of cash. TCGA92/S128 (2) provides consideration does not include
- any surrender, cancellation or other alteration of the original shares or of the rights attaching to them, or
- any consideration consisting of the application of the assets of the company or of a dividend or distribution declared but not made.
Provided by shareholder
The purpose of the second condition is to make sure that the consideration has to be provided by the shareholder and not the company. Consideration provided by the shareholder may not increase the company's net worth, the cash may be used to pay off creditors, but it will increase the company's resources. If the consideration is provided by the company any increase in the taxpayer's tax base cost will be artificial because there will be no corresponding increase in the company's resources.
Foreign stock dividends
You are most likely to see the operation of this rule in the case of stock dividendsdeclared by foreign companies. The company will declare a cash dividend but offer itsshareholders the option of taking up further shares instead of the cash. If a shareholdertakes the shares rather than the cash the company's assets have not been reduced by payingout the cash. To the extent that the shareholders opt to take their dividend in shares,the effect is similar to a bonus issue for which no consideration is given and you shouldtreat it in the same way. There is guidance on the Case V treatment of such dividends atIM1612.
UK stock dividends
For the treatment of a stock dividend by a UK resident company see CG58750+.
Bonus issue
A bonus issue following a repayment of share capital can be treated as an income distribution, see CT1540. The net amount of the distribution should be treated as the acquisition price of the new holding.
Anti-avoidance
The shareholder may try and create an allowable loss by subscribing for new shares to replace an irrecoverable or worthless loan. This type of transaction is illustrated in the case of Dunstan v Young, Austen & Young Ltd (61TC448).
Young, Austen & Young Ltd (YAY) beneficially owned all the shares in Jones Refrigeration Ltd (Jones). It wanted to sell these shares but Jones owed £200,000 to YAY and other group companies which it could not repay. YAY subscribed for a further 200,000 £1 ordinary shares in Jones which Jones used to repay the loans. YAY sold the shares in Jones. As discussed in CG51748 the subscription for the new shares was treated as a share reorganisation. YAY claimed a deduction for the £200,000 it had paid for the shares even though it was agreed the transaction was a bargain made otherwise than at arm's length.
If a taxpayer acquires an asset otherwise than by way of a bargain made at arm's length the Capital Gains Tax base cost will be established by TCGA92/S17. The market value of the asset will be substituted for the consideration paid to acquire the asset, see CG14530+. However, Section 17 cannot apply to a reorganisation because it is treated as not involving any acquisition of the shares. In the case of Dunstan v Young, Austen & Young Ltd the company was allowed its deduction.
TCGA92/S128 (2)
This loophole was blocked for reorganisations which occur on or after 10 March 1981 by what is now the second part of TCGA92/S128 (2). The subsection only applies if the consideration for the reorganisation is given otherwise than by way of a bargain made at arm's length. This requirement means that the anti-avoidance provisions in TCGA92/S128 (2) will not apply very frequently in practice. For advice on the meaning of the phrase `bargain made otherwise than at arm's length' see CG14540+. This would not apply to normal rights issues by a quoted company. In the context of reorganisations the facts of Dunstan v Young, Austen & Young Ltd and CIR v Burmah Oil Company Ltd (54TC200) give good examples of the type of case you should be looking for.
If a taxpayer acquires an asset otherwise than by way of a bargain made at arm's length the Capital Gains Tax base cost will be established by TCGA92/S17. The market value of the asset will be substituted for the consideration paid to acquire the asset, see CG14530+. However, Section 17 cannot apply to a reorganisation because it is treated as not involving any acquisition of the shares. In the case of Dunstan v Young, Austen & Young Ltd the company was allowed its deduction.
If the reorganisation is not a bargain made at arm's length the consideration given is restricted to the lower of
- the increase in market value of the new holding after the reorganisation over the value of the holding before the reorganisation,
or
- the actual consideration given for the new shares.
If you have agreed TCGA92/S128 (2) applies you should ask Shares and Assets Valuation (SAV), to negotiate the market value of the holding before and after the reorganisation. In other cases it may be worth asking SAV for an informal opinion see CG59560 before deciding whether to mount a challenge.
EXAMPLE
In 1986 A Ltd subscribes £200,000 for 200,000 £1 ordinary shares in B Ltd. B Ltd runs into financial difficulties and owes £500,000 to fellow group companies. A Ltd subscribes for a further 500,000 £1 ordinary shares in B Ltd. This is treated as a reorganisation and it is agreed it is a bargain made otherwise than at arm's length. SAV agree that the market value of A Ltd's holding of shares before the shares issue was £10,000 and after the reorganisation £50,000. Therefore, only £40,000 is added to the £200,000 base cost of the B Ltd shares owned by A Ltd.
At a practical level it may make little difference whether a subscription for new shares which is not a bargain made at arm's length is treated as reorganisation or a purchase. If the subscription is a purchase the ordinary rules of TCGA92/S17 will apply to restrict the acquisition cost of the new shares to their market value. The adjustment to the Capital Gains Tax base cost is likely to be very similar to that achieved under TCGA92/S128. See CG53516+ if the shares are issued on the conversion of a loan account.
The critical feature of both TCGA92/S17 and TCGA92/S128 is that you have to show the transaction is not a bargain made at arm's length within the ordinary meaning of those words. You cannot rely upon the connected persons legislation of TCGA92/S18 even if the subscription is treated as a purchase. Section 18 will only apply if there is a disposal and an acquisition. A company does not dispose of an asset when it issues its own shares. Therefore, there is no disposal by the company corresponding to the acquisition by the shareholder.
Indexation allowance
TCGA92/S131
If the shares were held at 31 March 1982 indexation allowance is only due from the date the taxpayer gave or became liable to give the new consideration, TCGA92/S131, see CG51632. The computation is illustrated in the Examples at CG51910 and CG51940. If the shares are held in a Section 104 holding the rights issue will be treated as an operative event. After you have added indexation allowance to the pool of indexed expenditure the cost of the new shares should be added to the pool of qualifying expenditure and the pool of indexed expenditure. The computation is illustrated in the example at CG51895.
NOTE. Indexation allowance does not apply for Capital Gains Tax from 2008-09.