The outcome of a recent First-tier Tribunal (FTT) case that examined the application of the substantial shareholdings exemption (SSE) may now lead to stand-alone companies rushing to incorporate dormant subsidiaries ahead of a possible sale in the future.
The case involved a situation where the trade and assets of a stand-alone company were transferred to a newly created dormant subsidiary that was subsequently sold. HMRC successfully challenged that the SSE did not apply to a disposal made by M Group Holdings Ltd (M Group), creating an additional tax liability on the company of £10.6m.
Until June 2015, M Group had traded as a stand-alone company. In June 2015 however it incorporated a wholly-owned subsidiary, MCS, and M Group transferred its trade and assets to that company. M Group subsequently sold the shares in MCS on 27 May 2016 for £54m, a transaction that occurred less than 12 months after MCS’s incorporation.
The SSE applies (broadly) when an investing company sells a substantial shareholding in another trading investee company it owns. Typically, a substantial shareholding is no less than 10% of the ordinary share capital of a company.
There are a number of other conditions that also need to be met for the SSE provisions to apply but, where they do, any chargeable gain (or capital loss) arising on the disposal of the shares is exempt from UK tax.
One of the other conditions is that the shares must be owned by the investing company for a continuous period of at least 12 months in the 6 years before disposal. Where trade and assets previously used in a trade by a member of a corporate group are transferred across a group however, the 12 month condition criteria is extended to include the time the asset(s) were previously used in a trade by the other group company.
In this case though HMRC successfully argued that, because M Group was a stand-alone company prior to the incorporation of MCS in June 2015, M Group had not been in a ‘group’ before the incorporation of MCS. Therefore, the period the assets were used in the trade of M Group prior to June 2015 could not be taken into account.
As MCS was then sold within 12 months of incorporation, the 12-month trading condition was not deemed to have been satisfied and the SSE was deemed not to apply.
The outcome of the case focussed on what had been Parliament’s intention in extending the 12-month trading condition to include the period the trade and assets were previously used by a member of a ‘group’.
The FTT indicated that it was unable to determine whether Parliament intended the extended provisions to provide relief for stand-alone trading companies acquiring and selling subsidiaries within 12 months. The FTT therefore concluded that they could only apply the legislation’s natural and ordinary meaning and a ‘group’ should be defined in its purest possible sense.
The hive down of trade and assets into a newly incorporated subsidiary is a common transaction undertaken by many groups ahead of them disposing of an entity within 12 months. It was (and is) therefore easy to assume that the rules would apply in a similar way for a stand-alone company. This case highlights that such assumptions should be avoided and there continues to be a number of risks associated with the application of the SSE.
It does appear however, that the SSE still applies to similar transactions where a subsidiary has been incorporated and held for at least 12 months so that the holding requirement is satisfied. Stand-alone companies may want to hold a dormant subsidiary for a period ahead of any transaction to provide access to the SSE when needed.
Incorporating a subsidiary to provide maximum flexibility for future disposals is something that has been advised for many years, but the rush of stand-alone companies heeding this advice may now be underway.