ICAS comments on Reform of the Substantial Shareholdings Exemption
Susan Cattell outlines the ICAS response to the Government consultation on reform of the Substantial Shareholdings Exemption.
What is the Substantial Shareholdings Exemption?
The Substantial Shareholdings Exemption (SSE) was introduced in 2002 to enable trading groups to make rational business decisions on restructuring, reinvestment and the disposal of shares in trading companies without being discouraged by potential corporation tax liabilities. It also aimed to discourage groups from adopting complex offshore holding structures which reduce transparency and create unnecessary administrative burdens for businesses and HMRC.
SSE applies where a gain arises on disposal of shares and, throughout a continuous 12-month period beginning not more than two years before the disposal, the investing company held a 'substantial shareholding' in the investee company (i.e. the company whose shares are the subject of the disposal). For this purpose a substantial shareholding is, broadly, an interest of at least 10%. The SSE also extends to certain assets related to shares, such as share options or convertible securities.
Why is reform needed?
The relief has failed to keep up with fundamental changes to the domestic and international tax landscapes since it was first introduced. Its provisions are now seen as lacking simplicity, competitiveness and coherence. There are also concerns about the potential for its application to be uncertain or dependent on factors outside a company’s control.
Options for Reform
The consultation proposed 5 possible options for reform which were discussed in detail in an earlier article 'The substantial shareholdings exemption: Options for reform'.
- Option 1: Comprehensive exemption
- Option 2: Exemption subject to investee trading test
- Option 3: Exemption subject to investee test other than trading
- Option 4: Amended trading tests at investee and investor level
- Option 5: Changing the definition of ‘substantial shareholding’
Option 1 would be attractive because of its similarity to participation exemptions in other jurisdictions. However, the consultation document made clear that it would require so many anti-avoidance provisions to address a list of concerns that it would be very complicated and probably of limited usefulness.
The consultation document indicated that a combination of options could be a possibility: a combination of options 2, 3 and 4 would be helpful and would address many of the problems encountered by companies seeking to use the current SSE regime.
Combination of Options 2,3 and 4
The benefits of this combination would include:
- Significant simplification, reduced costs and time saved. Currently, in order to evaluate whether the conditions for SSE are met, companies and their advisers have to spend time looking at entities which have no bearing on the UK activities but can determine whether a UK disposal is taxed or not.
- The exemption would be available whenever a trading company or sub-group is disposed of, even where the disposal is made by an investment company or a company within a substantially non-trading group.
- SSE could potentially be available where a holding company disposes of its entire trading group and decides that the best course of action is to invest the proceeds in some other way, or return the funds to shareholders. Currently SSE would not be available, due to the investor restrictions.
- In refining the investee test it would be useful to include property development as an acceptable activity. This would make the UK more attractive to real estate businesses, particularly important because the REIT regime is not perceived to be as attractive as some regimes in other jurisdictions.
- Focusing the tests on the companies involved in the transaction, rather than applying them at a group or sub-group level could help ensure that the availability of the exemption relies on factors over which a UK company has more control.
SSE and the funds sector
SSE is frequently not available to sovereign-wealth funds and pension funds. The UK investor company test is likely to deny access to SSE for the investment fund due to substantial non-trading activities. The use of offshore holding company structures (with access to overseas participation exemptions) is therefore attractive for exempt investors such as pension funds and sovereign wealth funds which would otherwise be in a worse position than if they had invested directly.
ICAS is supportive of extending the availability of SSE to the funds sector, as proposed in the consultation. This would make the UK a more attractive place for the funds sector and bring economic benefits to the UK. Through a targeted exemption for investment funds from the substantial non-trading activities condition, investment funds could use UK based holding platforms and still have access to SSE.
Areas of the SSE legislation which are ambiguous or produce outcomes that are inconsistent with the policy intention
The review of SSE presents an ideal opportunity to address some specific problem areas in the current regime.
Ordinary share capital
The focus on ordinary share capital in determining the members of a group can lead to anomalous results, for example, in the situation where companies are limited by guarantee. There can also be uncertainties with respect to shareholdings in overseas companies where the concept of ordinary share capital may not strictly follow the UK concept. This could be addressed by reference to an equity interest rather than ordinary share capital.
Trade/assets previously owned by another group company
Finance Act 2011 made a welcome amendment to SSE to extend the period over which a parent is treated as holding shares in a subsidiary where that subsidiary’s trade/assets were previously owned by another group company. This allowed groups to put trading activities into a newly incorporated subsidiary and then sell that subsidiary without share disposal gains being subject to corporation tax. However, it has subsequently emerged that there is a problem in the way HMRC interpret the legislation to exclude singleton companies carrying on several trades in divisions.
Singleton companies can take steps to bring themselves within the rules but HMRC’s approach creates a completely unnecessary complication and administrative burden. The legislation could be amended to make clear that the only interpretation is one that would allow singleton companies to benefit.
Finance Act 2011 also changed the rules on de-grouping charges (which arise when an asset is transferred on a no gain/no loss basis to a company that is then sold within 6 years). The change was to treat these de-grouping charges as additional consideration for the disposal in the hands of the seller. This means that the de-grouping charge is effectively extinguished where the disposal qualifies for the SSE. Again this was a welcome improvement to the SSE regime.
Unfortunately, the change was not extended to the intangible assets regime, in spite of the fact that this is closely modelled on the capital gains de-grouping rules. This significantly restricts the usefulness of the FA 2011 change to SSE de-grouping charges and therefore does not support the SSE policy intention of enabling trading groups to make rational business decisions on restructuring, reinvestment and the disposal of shares in trading companies without being discouraged by potential corporation tax liabilities. This anomaly could be corrected.
For a company to benefit from SSE on a disposal of shares in another company, it must have held a 10% shareholding in that company for a 12 month period in the 2 years prior to the disposal. In some cases share disposals may fail to qualify for SSE as a result of the sale of the residual shareholding in a company being delayed by circumstances outside the vendor company’s control.
The consultation proposes to address this by extending the period over which the 10% shareholding requirement can be satisfied to 6 years, in line with the period of consideration under the de-grouping rules. This seems a sensible proposal. It would also address a possible problem by limiting opportunities for groups to bring disposals made at a loss outside SSE by artificially delaying the sale of a rump shareholding.