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HMRC internal manual

Company Taxation Manual

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Groups & consortia: groups - entitlement to profits or assets available for distribution: example 1 - basic rule

ICTA88/SCH18

Background to example 1

The background to the example is that Company X is the true economic parent of Company Z. Company Z is undertaking a five year investment programme expected to give rise to Case I losses. So this creates the possibility that Company Z will be able to surrender group relief to Company X.

However Company X has no taxable profits, and is unlikely to have future taxable profits. If it were not for ICTA88/SCH18, a company with ample profits could group itself artificially with Company Z and purchase the relief for a fee. Assume that there is such a company, which has ample profits, and that it is called Company Y. After five years Company Z becomes profitable and starts paying dividends. Matters are arranged so that when Company Z pays dividends, Company X, which is the true parent, receives them.

Facts of example 1

Company X holds 100 £1 ordinary shares in Company Z.

The ordinary shares carry normal equity rights to share in profits.

Company Y holds 300 £1 participating preference shares in Company Z.

Each participating preference share is entitled to 1p of every £100 of profits distributed.

Under ICTA88/S832 (1), participating preference shares count as ordinary shares, however small the participation right may be. This means Company Y holds 75% of the issued ordinary share capital of Company Z. So Company Y and Company Z are members of a group within the terms of ICTA88/S413 (3)(a), even though the participating preference shares are of limited value. And Company Y could claim group relief from Company Z.

But when Company Z becomes profitable and pays dividends, the substantial amount of the dividends will go to Company X in respect of its ordinary shares. This indicates that Company X is the true economic parent of Company Z, and that the group relationship between Company Y and Company Z is a superficial one.

ICTA88/S413 (7) and ICTA88/SCH18 test the reality of superficial group relationships. ICTA88/SCH18/PARA2 applies here (CTM81035), and prevents Company Y from claiming group relief from Company Z. Assume that for the accounting period for which Company Y is seeking group relief, profits of Company Z are small or non-existent. If there are no profits, ICTA88/SCH18/PARA2 (1)(b) requires a figure of £100 to be taken as the profits available for distribution. Of this £100, £3 (300 x 1p) will go to Company Y. Company Y is thus entitled to only 3% of the profits and Company Z will not be treated as a 75% subsidiary of Company Y.