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HMRC internal manual

Company Taxation Manual

Particular topics: company winding up TAAR: exclusions

ITTOIA05/S396B/404A (7)

 

There are two exclusions in S396B/404A (7) that apply even where all of the conditions of S396B/404A are met.

 

Distribution of amounts representing base cost

The first exclusion is for any amount up to which, if S396B/404A did not apply, there would be no gain accruing for Capital Gains Tax. This is to ensure that amounts that represent a return to the investor of their “base cost” are not taxed as a distribution.

Example

Mr A is an IT contractor who provides his services through a company. Mr A’s only investment in the company was £1,000, which he used to subscribe for 1,000 £1 ordinary shares. He winds up the company and continues to provide an identical service as a sole trader. All of the conditions A to D of S396B/404A are met.

The amount of the distribution in the winding up is £100,000. Of this, £1,000 represents Mr A’s base cost and so is excluded from being treated as a distribution – in the terms of the legislation it “does not exceed the amount that would result in no capital gain accruing”. The remaining £99,000 will be treated as a distribution.

 

Distribution of irredeemable shares

Sometimes when a company is wound-up the shareholder receives shares as a distribution in the liquidation.  Although it is arguable that there is a tax advantage here, this is not the type of transaction that S396B/404A is aimed at.  To the extent that the distribution comprises irredeemable shares S396B/404A will not apply.

Example

Company A has one wholly-owned subsidiary, Company B which supplies car parts and accessories.  Company A acquired Company B some years earlier when the members had plans for extending the business but these did not come to fruition.  The shareholders wish to avoid the continuing expense of maintaining two companies and decide to liquidate Company A. The liquidator transfers the shares in Company B to the members as distributions in liquidation.  Company B continues trading.

The effect of CTA10/S1030 is that the distribution from the liquidation is not an income distribution.  S396B/404A will not apply either, to the extent the shareholders received irredeemable shares as consideration.  If, however the shareholders had received as consideration shares in Company B and cash of £100,000 then the exclusion from S396B/404A would not apply to the cash element.  Condition C (CTM36230) will be met because Company B’s activities continue as before.

There may be a chargeable gain in the hands of Company A’s shareholders on the capital distribution of Company B shares.

Reconstruction involving transfer of assets

Condition D is unlikely to be satisfied where there is a restructuring of the commercial architecture that involves transfers of assets followed by issues of shares, as in the following example.

Company C has two trades: an electrical supplies store and a hair salon. The shareholders take the view that these trades would be better served by being carried on in separate companies with no group ties.  This takes place through the “demerger” described below.

Company C reorganises and divides its share capital so that ‘P’ shareholders are entitled to the assets of the electrical supplies business and ‘Q’ shareholders are entitled to the assets of the hair salon business. Company C is wound-up and the electrical supplies business and assets are transferred by the liquidator to new company D, which issues shares to holders of ‘P’ shares in Company C. The liquidator transfers the salon business and assets to new company E, which issues shares to holders of ‘Q’ shares in Company C.  

The end result is that Company C no longer exists, and the original shareholders of Company C now hold shares directly in Company D and in Company E.

The effect of CTA10/S1030 is that the distribution from the liquidation is not an income distribution. TCGA92/S136 will also apply to the reconstruction, which means that there is similarly no chargeable gain in the hands of Company C’s shareholders: their new shares in Company D or Company E are treated as being the same asset as their shares in Company C.

S396B/404A will not apply either, as Condition D will not be met in these circumstances.