Getting a Share of Rollover Relief - PAUL HOWARD looks at rollover relief for gains on substantial shareholdings.

Getting a Share of Rollover Relief
PAUL HOWARD looks at rollover relief for gains on substantial shareholdings.
THE PRE-BUDGET statement included the Revenue's further proposals for new rollover relief for substantial shareholdings. The relief tries very hard to be helpful, and certainly is welcomed by many of those companies to whom it applies. If the proposals are approved, they are likely to form part of the 2001 Budget and the Finance Bill 2001.
The new proposals provide a 'bolt-on' to the existing rollover relief for replacement of business assets, and there are many who believed it should always have been there. The outline draft legislation, in respect of which the Inland Revenue has not asked for comments, is a reworking in plain English of the rollover relief provisions specifically for companies. It does not apply to capital gains tax for individuals or trustees.
Defining companies
Companies are defined, for the purposes of this relief, as being:
 a Companies Act 1985 or Companies (Northern Ireland) Order 1986 company;
 a company constituted under any other Act, Royal Charter, or letters patent;
 a company formed under the law of a country or territory outside the United Kingdom;
 a registered industrial and provident society;
 an incorporated friendly society;
 a building society.
The Government has yet to decide how to treat insurance companies and companies trading in the North Sea. Close companies are subject to special scrutiny, and under the original proposals were excluded completely. However, under the revised provisions a close company can qualify for relief if it is a trading company or the holding company of a trading group throughout the 'qualifying period'.
The definition of a trading company for the purposes of this new relief mirrors the business asset taper relief provisions, and is 'a company that, apart from purposes not capable of having a substantial effect on the extent of its activities, exists wholly for the purpose of carrying on one or more trades'. It is understood that further guidance will be produced to clarify what this might mean in practice – there certainly has been a whole gamut of interpretations offered for taper relief purposes, from the ridiculously pessimistic to the naively optimistic. Broadly, a 20 per cent test is likely to be applied, similar to the one applied to business expansion scheme and enterprise investment scheme reliefs. A trading group, for this purpose, is a holding company together with its 51 per cent subsidiaries.
What the relief does
The provisions of the relief will allow a company, as defined, to roll into or out of a business asset as listed in section 155, Taxation of Chargeable Gains Act 1992 into or out of qualifying shares or securities, so long as a number of conditions are met. This means that a company will, for example, be able to sell a factory it uses for the purposes of its trade, reinvest the proceeds into qualifying shares or securities and claim rollover relief.
Qualifying shares or securities means shares or securities of a trading company or the holding company of a trading group, again using the same definitions.
Requirements
As is to be expected, there are a number of requirements that need to be met in relation to the investor company and the company's shares acquired or sold, which are encompassed into the old assets and new assets familiar from the existing rollover relief provisions.
Old assets
In relation to old assets, in order to be regarded as qualifying shares or securities, the requirements will be as follows:
 The company making the disposal must have held a substantial shareholding (20 per cent) in the company whose shares are sold throughout the 12 month period before the disposal or for a period of 12 months ending within the 12 months prior to disposal. This allows for a piecemeal disposal of shares or securities in a company.
For example, if company X acquires a 20 per cent shareholding in company Y on 1 June 2000, and continues to hold those shares until 1 June 2001, when it sells half its holding, so long as it sells the remaining shares by 31 May 2002, it would be able to claim to rollover relief on the second tranche, as it would have had a substantial shareholding in company Y for a period of 12 months ending within 12 months of the disposal.
 The company in which the shares are sold must have been a trading company or the holding company of a trading group throughout the above qualifying period and any period between the end of that qualifying period and the time the shares are sold. This may be something outside the investing company's control, as it may have only a minority interest in the company. This could become more problematic if, in the above example, company X has only a ten per cent interest in company Y for almost a year, in effect having very little control over that company.
 The company making the disposal must have been a company to which this relief applies throughout the qualifying period. This is an issue confined to close companies, as any other type of qualifying company would remain so by virtue of its basic constitution. A close company looking to use this relief must be a trading company or the holding company of a trading group throughout the qualifying period.
New assets
The requirements that need to be met with regard to new assets which are shares or securities are as follows:
 The acquiring company must have a substantial shareholding in the company at some time in the reinvestment period (one year before and three years after the disposal of the old asset) and throughout a period of three years beginning with the first date on which the substantial shareholding was held. Again this allows for piecemeal acquisition, but once the substantial shareholding threshold has been reached, this must be retained for a three-year period. If additional shares are acquired in the company after the threshold has been reached, those shares must themselves be held for three years. The identification rules have not been drafted, but will, broadly, follow the identification rules in sections 104 to 114, Taxation of Chargeable Gains Act 1992.
 The company which is acquired must be a trading company or the holding company of a trading group throughout the above three year qualifying period. Again, this may be, to an extent, outside the control of the acquiring company.
 The company making the acquisition must be a company to which this relief applies throughout the three-year qualifying period.
If these requirements are not met, there would be a claw-back of relief, although the provisions have not been drafted. The claw-back will be treated as arising in the accounting period in which the claw-back event takes place, clearly for ease under self assessment.
Clawback provisions
There will be provisions to enable a clawed back gain to be reinvested, but no decisions have been made as to how this might work. The clawback provisions would also be designed to track reinvestments where there has been a share for share exchange, although that in itself is not likely to give rise to a claw-back.
One could envisage situations where rollover relief could be obtained, but never fall back into charge when the new assets are sold. This could, for instance, be achieved by distributing the assets of the acquired company, then selling the shares for a nominal sum.
However, things will not be quite so easy. Protective measures will be incorporated in the legislation to restrict relief where value is returned to the investing company in a non taxable way, or where there is a shift of value out of the company. Further anti-avoidance legislation will be introduced to target specific abuses.
Significant benefits
Nevertheless, the new relief will provide significant benefits to companies. For example, consider the situation where a company has disposed of a business asset falling within section 155, realising a significant gain, and has targeted a business it wishes to acquire, which is currently being carried on by a company. Under existing legislation the purchaser may prefer an asset purchase so as to maximise the rollover relief available on goodwill and freehold property, but the value attributable to those elements of the target business may be insufficient to give full rollover relief. At the same time there may be other assets, for example plant and machinery, stock, or licence agreements, which must be acquired and which absorb the proceeds of sale of the old business asset. If the purchaser wishes to maximise the rollover position, it would have to buy other qualifying assets.
Under the proposed changes, the purchaser would prefer, from a rollover relief point of view, to buy the shares in the target company, effectively obtaining rollover relief on the full value of that company. Rollover relief would in effect be available on stock, plant and machinery, even cash, so long as the target company is a trading company or the holding company of the trading group.
We may see a shift, therefore, towards share purchases and away from asset purchases, which is likely to benefit the vendors, who would themselves be able to benefit from capital gains tax reliefs.
Thus the relief that is proposed offers significant additional flexibility for companies investing in substantial shareholdings in other companies.
Substantial shareholdings exemption
However, a number of respondents to the first technical note issued in June suggested that an exemption for substantial shareholdings should be introduced, similar to the one that applies in a number of overseas jurisdictions. It is interesting to note that, although the Government has veered away from this proposal in favour of a rollover relief, the suggestion does not appear to have been rejected out of hand. There is a chapter in the November Technical Note considering how an exemption might work. If an exemption were to be introduced, however, it is likely to be very closely targeted.
The suggestion envisages the following broad principles:
 the qualifying shares are held by a trading company, or the holding company of a trading group;
 those shares themselves are in a trading company or the holding company of a trading group;
 there would be a minimum holding period of one year;
 there must be a substantial holding (20 per cent) throughout that period;
 on disposal there would be no chargeable gain or allowable loss.
We are probably a little way off from this corporate panacea. However, bearing in mind that similar reliefs are given in some European countries, if these provisions were enacted the United Kingdom would become an even more attractive Euro-location for corporate groups notwithstanding the mixer company debacle emanating from the 2000 Budget. Moreover, the company certainly would be the premier trading vehicle.
Paul Howard is a tax consultant with WJB Chiltern plc, and he can be contacted on 020 7339 9000.
 

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