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HMRC internal manual

Company Taxation Manual

Groups & consortia: groups - entitlement to profits or assets available for distribution: example 2 - limited rights


Background to example 2

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 2

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:

  • a fixed preferential dividend of 30p if there are sufficient distributable profits, and in addition,
  • 1p of every £100 distributed in excess of the fixed dividend.

Under ICTA88/S832 (1), participating preference shares count as ordinary shares. So, under ICTA88/S832 (1) and ICTA88/S838 (1), Company Y is a 75% shareholder in Company Z. This means Company Y and Company Z are members of a group within the terms of ICTA88/S413 (3)(a).

For the accounting period for which Company Y is seeking group relief, profits of Company Z are small or non-existent. But when Company Z becomes profitable and starts paying substantial dividends (and there is no more group relief to claim) Company X’s predominant equity rights on the ordinary shares will ensure that it receives the lion’s share of the dividends.

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, £90 (300 x 30p) will go to Company Y as a fixed dividend. Company Y will also receive 30p (300 x 1p x £10 / £100) from the distribution of the balance of £10. Company Y would thus be entitled to 90.3% of the distributable profits.

But ICTA88/SCH18/PARA4 (CTM81060 to CTM81065) prevents Company Y being regarded as entitled to 90.3% of the distributable profits. Paragraph 4 (1) applies because the participating preference shares carry rights in respect of dividend which are partly limited by reference to a specified amount (the fixed dividend of 30p per share). ICTA88/SCH18/PARA4 (2) applies, and the limited rights are treated as waived. So, on a distribution of £100, Company Y would be entitled to £3, and Company X would be entitled to the remainder of £97. By virtue of paragraph 4 (3) Company Y is treated as entitled to only 3% of the profits, the lesser of the two figures under:

  • paragraph 2 (1), that is £90.30, and
  • paragraph 4 (2)(a), that is £3.

Company Z will not therefore be treated as a 75% subsidiary of Company Y.