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I was discussing the benefits of Substantial Shareholder Exemption (SSE) with a client the other day and found myself using one of my Gran’s favourite expressions – “you want your cake and to keep your half penny”. Before this seems to look like a ramble down memory lane, I had better look in a little more detail at SSE in an attempt to explain my musings.
SUBSTANTIAL SHAREHOLDER EXEMPTION – THE FAQs
In summary SSE provides a relief which broadly exempts from taxation gains made by companies on the disposals of a substantial shareholding in another company. This enabled , typically, a group to dispose of its interest in shares (or assets relating to shares) in a subsidiary with no tax cost (when sold at a profit) but also no tax relief (when sold at a loss).
A substantial shareholding is defined as 10% or more of the ordinary share capital, so the application of SSE is somewhat wider than just groups.
The rules, introduced in 2002, were significantly revised and relaxed from 1 April 2017 and are now much more user friendly. For the purposes of this article the key change was the complete removal of the condition requiring the selling company (or group) to be trading and one impact of these changes is that, with planning, SSE can now be used in an effective way in the typical OMB/SME environment.
The rules are detailed and anything other than a brief introductory overview, to set the scene, is beyond the scope of this article;
• The legislation refers to the investing company , the one making the disposal and the investee company , the company whose shares are being disposed of,
• Substantial shareholding means at least 10% of the ordinary share capital or 10% of the profits for distribution to equity holders or entitled to 10% of the assets to shareholders on a winding up,
• Trading company/group – a company carrying trading activities , which are not to a substantial extent non- trading activity,
• Both these tests are found elsewhere in the tax legislation (Entrepreneurs Relief for instance ) and raise the same issues,
• The investing company must hold the relevant qualifying shareholding throughout a 12-month period,
• Although typically the 12-month period is the final 12 months of ownership the changes from 2017 extended the actual holding period from any 12-month period in the two years up to the date of sale to six years. This is particularly helpful where there is an earn out period,
• A further change from 2017 removed the requirement that the investing company be a trading company, I look at the impact of this important change below,
• A further change from 2017 removed the requirement that the investee company be a trading company immediately after disposal, this could cause issues where the purchaser immediately hived up the trade on acquisition. The requirement remains where the disposal is to a connected person or the trade has been transferred within the past 12 months.
The 12-month requirement can be met where there has been a transfer of part of a group trading asset to a newly formed company where;
• The assets were held by another group company and used for the purposes of its trade,
• Those assets, at the time of the disposal, are being used for the purposes of the investee company’s trade
• Immediately before the disposal, the investing company holds a substantial shareholding in the investee company.
In other words, the investing company’s 12 month holding period is extended to include any time in the final 12-month period in which the group company held the asset.
As a result, where the company has one or more trading activities, it is possible to undertake planning for the pre-sale packaging of the trading activities using newco (s) as a clean (and thus more attractive) vehicle to enable these to be sold without the vendor company suffering a tax charge.
HMRC are understood to take the view that the asset must be used by another group company and that there must, therefore, initially be a group.
This seems to be tenable if the legislation is read literally but seeing that HMRC now seem to argue that a purposive interpretation of the legislation should be applied somewhat inconsistent!
Tax Planning, SSE vs. Entrepreneurs Relief
Nonetheless, forward planning is possible and the removal of the trading requirement for the investing company means that planning for SSE is a viable and more cost effective alternative to Entrepreneurs Relief where the shareholders are happy with a cash box or family investment company (FIC).
The use of a FIC gives further planning opportunities and sticking with my cake analogy gives scope for at least two cakes and retaining the half penny.
For more information on SSE and tax planning please get in-touch. You can also read more articles, help and advice about tax reliefs for businesses and for private clients below.