Revenue Note for Guidance

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Revenue Note for Guidance

817 Schemes to avoid liability to tax under Schedule F

Summary

This section counteracts a variety of schemes and arrangements which enabled the profits of closely held companies, which were available to be paid out as dividends, to be transferred to the companies’ shareholders in a form which produced greatly reduced liabilities to tax. Essentially, the objective of all the schemes was to enable shareholders to extract profits from a company free of income tax by means of a disposal of shares without reducing their ownership of the company.

The schemes converted what was, in effect, a distribution of profits to shareholders into the proceeds of a disposal of shares by the shareholder. The income tax which would otherwise have been charged was converted to a much reduced charge to capital gains tax.

The continued undiluted ownership of the companies in question by the same shareholders, on the completion of these schemes, demonstrated the essential tax avoidance nature of the arrangements.

This section charges the net proceeds of disposals of shares to income tax where there is no genuine disposal of ownership of a business. Bona fide disposals of shares, which are not part of an arrangement to avoid tax, are specifically excluded from the provisions of the section.

Details

Definitions and construction

(1)(a) Certain terms used in the section are defined and these are self-explanatory. It should be noted, however, that the term “shares” is given a wide meaning so that the section includes all disposals of interests in a company as part of schemes or arrangements for avoidance of income tax under Schedule F.

(1)(b)(i) The provisions of the Capital Gains Tax Acts are adopted for determining whether there has been a disposal of shares. It is also clarified that a part disposal of shares (which is treated as a disposal for the purposes of the Capital Gains Tax Acts) is a disposal of shares for the purposes of the section.

(1)(b)(ii) [In some schemes to avoid income tax chargeable under Schedule F a profitable trade is transferred from one company A to another company B. Company A’s shareholders receive shares in company B in proportion to their holdings of shares in company A. Cash and other liquid assets are retained in company A which is then liquidated. The transfer of the trade from company A to company B is normally treated as giving rise to a part disposal of company A shares by company A’s shareholders. This is because value has passed out of those shares and into the shares in company B. The normal treatment ignores the part disposals of company A shares by company A’s shareholders who are treated as having acquired the company B shares at the time they acquired the company A shares and for the cost of acquisition of the company A shares.]

(1)(c) This “roll-over” treatment in the case of reconstructions involving pro-rata share issues is not given under capital gains tax legislation in cases involving tax avoidance. The provisions of that legislation in so far as they deny a roll-over treatment in respect of disposals of shares in reconstructions undertaken for the purpose of tax avoidance complement the provisions of this section. However, as that capital gains tax measure could also be construed as casting doubt on whether a transfer of a trade from one company to another was to be treated as resulting in a disposal or part disposal of the first company’s shares, any such construction is prevented and it is confirmed that the reconstruction is to be treated as giving rise to a disposal or part disposal which may be a disposal to which this section applies.

Provisions of the corporation tax law are adopted for the purposes of specifying the circumstances in which the interest of a shareholder in a trade or business will not be treated as significantly reduced following a disposal of shares or the carrying out of a scheme or arrangement of which the disposal is a part.

A comparison is to be made of the shareholder’s interest in the specified trade (through any company) at any time before the disposal and at any time after the disposal. The times by reference to which the comparison of interest is to be made are not defined beyond the requirement that one be before the disposal of shares and the other after the disposal. This is to prevent temporary reductions of interests being arranged in order to get around the section.

The comparison is to be made between the shareholder’s percentage shareholdings and percentage entitlements to profits and assets of the company carrying on the specified business at the time before and the time after the disposal. The shareholder’s interest in the specified business may be through different companies at the times when the comparison is made.

The first percentages to be compared are the percentages of ordinary shareholdings in the company carrying on the specified business beneficially owned by the shareholder.

The second percentages to be compared are the percentages of a full distribution of profits by the company carrying on the specified business to which the shareholder would be entitled.

The third percentages to be compared are the percentages of assets available for distribution on a notional winding up (at the times by reference to which the comparison is to be made) to which the shareholder would be beneficially entitled.

If there is no significant reduction of interest by reference to either the first, or the second, or the third pair of percentages to be compared, the shareholder will not be treated as having significantly reduced his/her interest in the specified business.

(1)(ca) Following a disposal of shares in a close company by a shareholder, any interest which that shareholder has in the trade or business carried on by the company —

  • (1)(ca)(i) is deemed to include any such interest held by persons connected with the shareholder, but only where that results in the shareholder’s interest not being “significantly reduced”. (This effectively narrows the circumstances in which the shareholding of connected persons is included. A genuine disposal of a shareholder’s interest, without any change in a connected persons interest, is not caught by this provision.),
  • (1)(ca)(ii) notwithstanding paragraph (c), is deemed not to have been “significantly reduced” where the following two conditions are met —
    • the business of the close company is predominantly a holding company, and
    • the interest the shareholder subsequently has in the business activities previously carried on by the subsidiary companies in the group has not “significantly reduced”.
      This means that the shareholder’s control over all the activities of the group is not “significantly reduced” despite the sale of shares in or the liquidation of the holding company,
  • (1)(ca)(iii) notwithstanding paragraph (c), is deemed not to have been “significantly reduced” where the gain realised, or the proceeds in either or both money or money’s worth received, by the shareholder from the disposal of a company is wholly or mainly attributable to payments or other transfers of value to it from any other company which is controlled by the shareholder, whether directly or together with persons connected with him or her, and
  • is deemed not to have been “significantly reduced” where—
  • (1)(ca)(iv) there would be no “significant reduction” if shares held by a trust, of which the shareholder is a beneficiary or could be a beneficiary, were treated as in the beneficial ownership of the shareholder,
  • the acquisition of the shares by the trust was directly or indirectly related to a disposal of such shares by the shareholder, and
  • the shares were acquired by the trustees with the direct or indirect financial assistance of a company or companies controlled by the shareholder or by the shareholder and persons connected with him or her.

(1)(d) The value of any amount received in money’s worth is to be taken as the market value of the money’s worth at the time of receipt.

(1)(e) For the purposes of this section the holding of money by a company is deemed to be a business carried on by the company regardless of how that money was contributed to or acquired by the company.

Purpose of section

(2) A broad statement of the purpose of the section is made. It is intended to counteract schemes to avoid income tax under Schedule F which a close company either undertakes or takes part in. The avoidance is summarised as the extraction of value from a company without making a payment of a dividend or other distribution, for the purposes of avoiding the income tax charge under Schedule F on such dividends.

Application

(3) The circumstances in which the section applies are specified. If a shareholder disposes of shares (“shares” in the context of this section is given a very wide meaning – see above) in a company without diminishing his/her ownership of the business carried on by the company at the time of the disposal, the section applies to the disposal. There must be such a disposal of shares for the section to apply to the disposal.

Although there must be such a disposal of shares for the section to apply, the section does not automatically apply if there is such a disposal. The section does not apply automatically to a disposal of shares within the terms of this subsection because the subsection is made subject to subsection (7). [Subsection (7) requires that the section does not apply to a disposal if it can be shown that the disposal is not part of an arrangement to avoid tax. Accordingly, disposals of shares for purposes which do not include tax avoidance are excluded from the scope of the section whether or not they result in a significant reduction of the interest of the shareholder in the business carried on by the company.]

The charge to tax as a distribution in respect of proceeds of share disposals

(4) The proceeds of a disposal of shares to which the section applies or the net proceeds, as the case may be, are treated as a distribution made by the company to the shareholder disposing of the shares. The distribution is treated as made by the company at the time of the disposal of the shares by the shareholder. The effect of treating the proceeds of the disposal as a distribution is to deny the advantage sought by way of schemes which would replace straightforward dividend payments by capital receipts which are not chargeable to income tax. The capital receipts are made chargeable to income tax in the same way as a dividend would be.

Limit to amount treated as distribution

(5)(a) The essence of the definition of “capital receipt” is that the proceeds of a disposal of shares is not considered a capital receipt in so far as those proceeds are simply more shares in a company carrying on the “specified business” (which produced the distributable profits in the first place). If a shareholder has merely swapped one form of share ownership of a business for another he/she is not treated as having received a “capital receipt” for the purposes of subsection (5).

(5)(b) There is a limit to the amount which may be treated as a distribution received by a shareholder by virtue of the section at any time. The limit at any time is the total value of “capital receipts” received by the shareholder at that time as a result of the disposal of shares to which the section applies or as a result of a scheme or arrangement of which the disposal of shares is a part. Accordingly, a shareholder cannot be treated as having received a distribution under the section if he/she has merely exchanged one form of share ownership of the specified business for another.

(5)(c) What is implied by the preceding provisions of the section is put beyond doubt, that is, that so much of the distribution under subsection (4), as does not exceed the limit by reference to capital receipts set by this subsection, is treated as having been received by the shareholder. Furthermore, irrespective of the date on which the shareholder receives the capital receipt which results in the shareholder being treated as having received a distribution or part of a distribution, that distribution is treated as made at the time the disposal of shares was made by the shareholder.

Interest

(5)(d) Interest is only chargeable on income tax referable to a distribution under this section from the date of the capital receipt which gives rise to the charge.

Exclusions

(7) Finally, it is provided that although a disposal of shares would otherwise come within the terms of subsection (3), that is, the disposal does not significantly reduce the shareholder’s interest in the specified business, the section does not apply to the disposal if the shareholder demonstrates that it was for a bona fide commercial purpose. This complements subsection (2) in so far as it ensures that disposals of shares will only result in a charge to income tax by virtue of this section where they are part of a scheme or arrangement to avoid income tax under Schedule F.

Relevant Date: Finance Act 2018