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HMRC internal manual

Company Taxation Manual

Groups & consortia: groups - entitlement to profits or assets available for distribution: example 4 - option rights


Background to example 4

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 4

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 ordinary shares.

Company X has an option to acquire Company Y’s shares exercisable after five years.

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 are small or non-existent. But when, as expected after five years, Company Z becomes profitable and starts paying dividends, Company X will exercise the option and acquire all the ordinary share capital in Company Z.

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/PARA5B (CTM81090 to CTM81100) prevents Company Y being regarded as entitled to 75% of the distributable profits. Paragraph 5B (1) applies because there are in existence option arrangements satisfying the conditions of paragraph 5B (2) to (4). Paragraph 5B (5) to (8) applies, and the option right is treated as exercised. This means that Company X is treated as acquiring all Company Y’s shares. So, upon a distribution of £100, Company X would be entitled to £100 and Company Y to nil. ICTA88/SCH18/PARA4 (3) applies by virtue of paragraph 5B (10). So Company Y is entitled to nil, the lesser of the respective percentages under:

  • paragraph 2 (1), that is £75, and
  • paragraph 5B (8)(a), that is nil.

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