Taper Relief In Excel(sis)

PETER RAYNEY FCA, FTII, TEP extols the virtues of a nifty taper relief dilution spreadsheet program which he has devised.

In the post Finance Act 2000 capital gains tax business asset taper relief régime, I have seen a number of taper relief permutations beginning to emerge on the sale of owner managed business shareholdings. Certain situations tend to repeat themselves, such as where the shareholder's pre-6 April 2000 taper period did not qualify as a business one under the tighter criteria in the original Finance Act 1998 rules.

'Diluted' shareholders

Where shares in a trading company, or holding company of a trading group, are being sold, some or all the shareholders will generally suffer a two year non-business dilution in their taper relief in the following common situations:

Less than five per cent shareholder

Where a full-time working shareholder possessed less than five per cent of the voting rights.

Less than twenty-five per cent shareholder

Where a shareholder, with less than 25 per cent of the votes, is unable to demonstrate that he had worked for the relevant company, or any related group company or commercial association of companies, on a full-time basis in the two years to 6 April 2000. This often arises with shares held by non-working or only part-time working spouses in a family company. Another less typical scenario occurred on a deal I recently advised on. Here the two principal shareholders had reduced their shareholdings in 1997 by various gifts to family members/trusts. Unfortunately, they had also been advised to supply their services to the Target company via personal service companies. I concluded that there was no realistic basis for contending that these principal shareholders were full-time working directors or employees of the Target company in the relevant period. They had clearly worked for their personal service companies that in turn received administration fees for the services they supplied (for about three years) to the Target company.

Trustee shareholders

In many trustee shareholdings, since trustees tend not to have the requisite 25 per cent voting power, or, in the case of a life interest trust having at least five per cent of the votes, the life tenant will not meet the 'full time working officer/employee' requirement.

Other situations

Other notable categories of shareholder with the same pre-6 April 2000 diluted taper relief profile include:

• Certain minority director/employee-shareholders of investment companies; such shareholders will have a business taper period from 6 April 2000 onwards, irrespective of the underlying company's status. This favourable treatment is only available to those holding a non-material interest, i.e. not exceeding ten per cent of issued share capital, voting rights, loan notes. The ten per cent threshold is tested by aggregating shares held by an individual's relatives and other associates with those held by them.
• Shares held by directors and employees of quoted companies; these invariably became business assets from 6 April 2000 by virtue of the shareholders satisfying the officer/employee criterion in paragraph 6 of Schedule A1 to the Taxation of Chargeable Gains Act 1992.
• Shareholders of a company which was prevented from having qualifying trading company/group status due to the existence of substantial equity investments in joint venture trading companies. From 6 April 2000, such joint venture interests are deemed to represent an appropriate part of the trading activities of a trading company/group for determining the company's taper status. Under paragraph 23 of Schedule A1, a company's investment in a joint venture company qualifies for trading treatment provided it holds more 30 per cent of its ordinary shares and:
  • it is a trading company or holding company of a trading group, and
  • at least 75 per cent of its equity share capital is held by five or fewer United Kingdom or non-resident companies.

Dealing with 'diluted' shareholders

All the above mentioned categories of shareholder will normally be able to treat the period after 5 April 2000 as a business one for taper relief purposes when unlisted shares in most companies became business assets. On a subsequent sale, the shareholder's taper relief entitlement would be diluted by the non-business period for the two years ended 5 April 2000, or the appropriate shorter period, for shares acquired during those two years. These diluted shareholders will have to wait up to 12 years before the pre-6 April 2000 non-business period is fully eliminated from their taper relief calculations. This is because the relevant period of ownership for taper relief is taken from 6 April 1998 or, if later, when the shares were acquired, to the disposal date. (For newly formed close companies, the taper base date may begin when trading starts under the rule in paragraph 10 of Schedule A1.) If this period exceeds ten years, the ownership period becomes the ten year period before the disposal (paragraph 1 of Schedule A1).

If the shareholder has built up his shareholding in stages, then each block of shares is treated as a separate asset with its own period of ownership. Shares held at the start of the taper relief régime on 6 April 1998, i.e., the section 104, Taxation of Chargeable Gains Act 1992 pool, are effectively treated as a single composite asset and can only be increased by subsequent bonus or rights issues under the reorganisation rules.

The dilution problem will remain after 5 April 2002, when full business taper will be given after just two complete years, with 50 per cent taper being available after one year (as confirmed in the Chancellor's pre-Budget report on 27 November 2001). This is because the original and earliest taper relief base date of 6 April 1998 will be retained under the post-Finance Act 2002 régime. Clearly, under the current rules, most 6 April 1998 shareholders would have reached their maximum business taper reduction by 6 April 2002 (see below). Hence, in reality, the new two year rule only improves the taper relief position for post-5 April 1998 share acquisitions.

It is worth noting that the shorter two year wait is likely to make it more attractive to eliminate the pre-6 April 2000 non-business period by restarting the shareholder's taper relief clock. Typically, this will involve the shareholder transferring his shares to a life interest trust for his benefit under the protection of a section 165, Taxation of Chargeable Gains Act 1992 business asset hold-over election. (I summarised the relevant issues in Taxation, 14 September 2000 at page 615.)

Apportioning gains

If a shareholder's taper relief period includes a non-business period, detailed calculations are required since the gain must first be split into two elements: the business gain and the non-business gain. This is achieved by apportioning the capital gain, after any indexation frozen at April 1998 and any retirement relief entitlement, between the business and non-business periods by reference to the number of days in each period. The relevant taper relief rate is then applied to each element of gain, based on the entire (post 5 April 1998) period of ownership of the block of shares (paragraph 3(2) to (5) of Schedule A1).

Taper relief rates

For disposals between 5 April 2000 and 5 April 2002, the top 75 per cent taper reduction is reached after just four complete years. For shares held at 6 April 1998, the chronological build up of business asset taper is 25 per cent in 2000-01, 50 per cent in 2001-02 and 75 per cent after 5 April 2002. (No bonus year is given for business asset taper on post 5 April 2000 disposals.)

In contrast, non-business or investment assets only attract five per cent taper relief after three complete years of ownership (with a bonus year available on assets held on 16 March 1998 assets). Thereafter, further non-business taper accrues at the rate of five per cent for each complete year rising to a maximum of 40 per cent (equivalent capital gains tax rate of 24 per cent for higher rate taxpayer) after ten years. For shares held at 5 April 1998, the build up of non-business taper is as shown in Table 1.

Extending the shareholder's taper period

Many owner managed company sales involve the vendors taking shares or loan notes in the purchasing company as part of their takeover consideration. Broadly, this enables the appropriate part of the vendor's capital gains tax to be deferred, provided the Revenue is satisfied that these elements of the transaction are for genuine commercial purposes (and hence the potential section 137, Taxation of Chargeable Gains Act 1992 hurdle is cleared). Advance clearance should be obtained on this point under section 138, Taxation of Chargeable Gains Act 1992, as well as section 707, Taxes Act 1988.

Taking shares and non-qualifying corporate bond loan notes will, among other things, enable the vendor shareholder to extend his taper relief period beyond the takeover date. (The section 135 share exchange provisions apply the general capital gains tax reorganisation rule in section 127 with the vendor being treated as having acquired the new shares/securities at the same time, and cost, as his old shares.) Vendors enjoy similar treatment on earn-out transactions which are to be satisfied by the purchasing company's shares or loan notes, provided the vital section 138A election is made (see my article in Taxation, 20 July 2000 at pages 413 to 419).

Qualifying corporate bond loan notes

Vendors must note that, if they take qualifying corporate bond loan notes, their taper relief position will effectively be frozen at the date of the takeover. This is because section 116(10), Taxation of Chargeable Gains Act 1992 requires the capital gain to be calculated by reference to a notional disposal of the 'old' shares in the Target company at the original takeover date. The gain (after deducting any residual retirement relief) is then held-over and crystallises when (and to the extent that) the loan note is repaid.

Technically, it is at this point that taper relief is given, but it is only computed up to the date of the original disposal (paragraph 16 of Schedule A1).

Post-takeover period

Many vendors will wish to ensure that their post-takeover period rolls forward as a business one, otherwise (back-ended) dilution of their business taper will occur.

If the acquiring company is unlisted (which includes Alternative Investment Market companies), then there is usually little difficulty (since unlisted trading company shares/securities will generally qualify).

On the other hand, if the acquirer is listed, further work may be necessary to ensure full business taper is kept. Unless the vendor receives consideration shares representing at least five per cent of the voting rights in the acquirer, the normal method of ensuring continuity of business taper is to retain their directorship or employment with the Target company (or indeed hold such a position with any company in the acquiring group). A part-time engagement will suffice, so as I am a proud Sainsbury's shareholder it is quite tempting to get a part-time job at my local store pushing trolleys around on a Saturday afternoon to obtain business taper on my shares.

In these cases, from 6 April 2000, the purchasing company may not have to fulfil the strict requirement of being a trading company or holding company of a trading group. The relaxation for minority director/employee shareholdings will often apply which enables business taper relief to be enjoyed irrespective of the company's status (see above). Thus, for example, minority employee-shareholders of a listed property investment company will secure business taper relief for any post-5 April 2000 period (paragraph 6(1A) of Schedule A1).

The taper dilution (EXCEL) spreadsheet

I have found that it is very useful to have my taper relief dilution spreadsheet on the numerous occasions on which I have advised the afflicted diluted shareholder. A simplified version of the Excel-based spreadsheet appears below.

The spreadsheet calculates the effective rate of capital gains tax after deducting the appropriate rates of business/non-business taper relief, the respective gains being apportioned on a daily basis. This can be used to determine an acceptable date on which to make a disposal or structure/redeem a non-qualifying corporate bond loan note. The effective rates are for a 40 per cent taxpayer and a 34 per cent taxpayer, such as the trustees of a non-settlor interested trust. The original Excel spreadsheet can easily be amended to deal with, say, 20 per cent taxpayers or subsequent non-business periods, for example as a result of leaving employment after a share for share based takeover, (see above).

If you would like me to send you a copy of the original formula based sheet, please e-mail me at peter_rayney@bdo.co.uk. Consider it a seasonal present between like-minded taper aficionados!

Peter Rayney is a tax partner with BDO Stoy Hayward in the West Midlands, where he provides a tax consultancy service to accountants and lawyers as well as owner-managed businesses. He is also the lead author of Tax Planning for Family and Owner Managed Companies – 2001-02 published by LexisNexis Butterworths Tolley.

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