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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 3 - varying rights for different accounting periods

ICTA88/SCH18

Background to example 3

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 3

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 special shares in Company Z.

The special shares carry the same rights as the ordinary shares but after five years cease to carry any rights, except to the return of the capital subscribed.

Company Y is a 75% shareholder in Company Z (ICTA88/S832 (1)) and ICTA88/S838 (1)). 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, as expected after five years, Company Z becomes profitable and starts paying dividends, the special shares will have lost their dividend rights and all the dividends will be paid to Company X.

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, £75 (£100 x 300 / 400) will go to Company Y.

But ICTA88/SCH18/PARA5 (CTM81070 to CTM81075) prevents Company Y being regarded as entitled to 75% of the distributable profits. Paragraph 5 (1) applies because the shares carry rights in respect of dividend which are of such a nature that, if the profit distribution were to take place in a different accounting period, Company Y’s percentage entitlement would be different. Paragraph 5(2) applies, and the rights are treated as the same as they would be in the later accounting period. Company Y’s shares do not have any rights to dividends in the sixth and later accounting periods. So, on a distribution of £100, Company X would be entitled to £100 and Company Y to nil. ICTA88/SCH18/PARA4 (3) is applied by virtue of paragraph 5 (4), and Company X is treated as entitled to nil. This is the lesser of the respective percentages under:

  • paragraph 2 (1), that is £75, and
  • paragraph 5 (2)(a), that is nil.

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