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HMRC internal manual

Capital Gains Manual

HM Revenue & Customs
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Share exchange: examples


Transactions involving TCGA92/S135 are undertaken for a variety of commercial reasons. The following examples are given by way of background information. Any decision on whether a particular exchange meets the bona fide commercial reasons test in TCGA92/S137 is the responsibility of

  • Clearance & Counteraction Team, Anti-Avoidance Group in relation to an application for advance clearance, or
  • Capital Gains Technical Group, in all other cases.

The takeover

The takeover in which one company acquires the shares in another in exchange for the issue of its own shares or debentures is the most straightforward situation. It can take a variety of forms. There is the takeover of a quoted company. Usually this will be done by means of a general offer made to all the shareholders in the target company. Even in what is essentially a cash offer it is common for the acquiring company to include what is sometimes called a loan note alternative. The company will offer to issue debentures rather than pay cash. This will allow the shareholders to defer any Capital Gains Tax liability but may also have commercial benefits for the acquiring company in that it is able to defer part of the cost of purchase until the notes are redeemed. This should not be for at least 6 months after the date of their issue, but they may not be capable of redemption for a considerably longer period.

Agreed takeovers of private companies are also common. Usually all the shareholders will sign a single share sale agreement with the purchaser. The agreement may entitle the shareholders to further consideration which is dependent on the future profits of the company, see CG52560. If the shareholders do not want the shares issued by the acquiring company these may be sold on their behalf in a vendor placing, see CG51763.

At the extreme there is the reverse takeover, in which the acquiring company issues so many shares the original shareholders lose control to the new shareholders and the acquiring company changes hands. This is often seen as a way of getting a Stock Exchange listing if a small company with a listing acquires a much larger unquoted company in exchange for an issue of its own shares.

The grouping exercise

For historical or commercial reasons a taxpayer or group of taxpayers may have developed their business interests through a number of associated companies. For example, a husband and wife or civil partners may own all the shares in a number of separate companies, each of which operates a shop. The individual companies will not be able to take advantage of the various reliefs that are given to groups of companies. Therefore, a group structure is created by putting a new holding company above all the companies or making one of the existing companies a new holding company. The holding company will acquire all the shares in the other companies in exchange for an issue of its own shares.

It is quite common for there to be an intra-group transfer of assets after the grouping. Usually this will have no bearing on the validity of the clearance. The ability to move assets around the group may have been one of the reasons for the grouping. However, you should be concerned if any of the shares in the original companies are sold out of the group. These shares will have been acquired by the holding company at market value (see CG52610+).

The buy-out

A share exchange is one method of effecting a management buy-out.

Example: Mr Rolls and Mr Royce each own 50 per cent of the shares in Silver Shadow Ltd. Mr Rolls wants to retire and Mr Royce wants to buy his shares. A bank is willing to lend the money to Mr Royce, using the assets of Silver Shadow Ltd as security for the loan. The Companies Act restricts companies from providing financial assistance for the purchase of their own shares. Therefore, Mr Royce incorporates a new company, Newco Ltd. Newco Ltd acquires all the shares in Silver Shadow Ltd. It pays Mr Rolls cash and issues shares to Mr Royce. The bank lends the funds to Newco Ltd secured on the assets of its new subsidiary, Silver Shadow Ltd. Mr Royce now owns all the shares in Newco Ltd at the same cost to him as his shares in Silver Shadow Ltd.

There is a great variety of this type of scheme. Financial institutions and venture capitalists may provide the funds for the buy-out by taking a shareholding in the new company. As an alternative to receiving a cash payment the retiring shareholder may be prepared to accept debentures in the new company.

The separation

A new holding company may be put above an existing company in a deliberate attempt to separate the new company from the existing business. After a company has been trading for some time it may have built up a number of contingent liabilities, commitments and warranties. Prospective purchasers of the company may want to distance themselves from these potential liabilities. The purchaser would prefer to buy shares in a clean new company. Therefore, a new holding company acquires all the shares in the old company in exchange for an issue of its own shares. A sale of shares in the new holding company will not normally require a report to Clearance & Counteraction Team, Anti-Avoidance Group. The shareholders will have acquired the new shares at the original cost of the old shares because of the operation of TCGA92/S135. The full amount of any capital gain will be charged when the new shares are sold.