Degroup With Care

ROBERT JAMIESON MA, FCA, FTII provides an update of the degrouping charge rules in the light of the Finance Bill.

A TAX CHARGE exists under section 179, Taxation of Chargeable Gains Act 1992, where a subsidiary leaves a 75 per cent group, having acquired a chargeable asset from another group member within the previous six years. The subsidiary must still hold the transferred asset.

The degrouping charge was designed to put a stop to the so-called 'envelope scheme'. This scheme has been explained by one company tax commentator as follows:

Calculation and timing

Where a company leaves the group, section 179(3) provides that the tax liability is calculated on the basis that the transferee company sold and immediately reacquired the asset in question for its market value at the time of the original intra-group transfer.

The resulting gain (or loss) is then treated as arising on the later of:

• the first day of the accounting period in which the company left the group; or
• the date of the intra-group asset transfer.

Reallocation

The reallocation of the degrouping charge is included as clause 41 as part of the package of reforms to corporate chargeable gains of which the substantial shareholding exemption is the major component. It introduces a new section 179A, which enables all or part of a gain (or loss) arising as a result of the degrouping legislation to be reallocated to one or more members of the group.

It effectively parallels the 'notional transfer' rules in section 171A, which only apply to actual disposals of assets.

The main conditions which must be satisfied in order for an election under section 179A to be valid follow.

The company to which the degrouping gain is reallocated must be a member of the same group as the section 179 company at the time when the gain is deemed to accrue to the latter company. Thus, in Example 1, the gain of £160,000 accrues on 1 July 2002, on which date both Gallagher Ltd and Ingram Ltd were still members of the same group.

Where two or more elections are made, e.g. because more than two group companies are involved, the total amount of the gain reallocated cannot exceed the gain which arose to the section 179 company in the first place.

At the time when the gain is deemed to accrue, the company to which the degrouping gain is reallocated must either be United Kingdom resident or else own assets which are within the scope of United Kingdom corporation tax on chargeable gains. In Example 1, it is assumed that Ingram Ltd is United Kingdom resident.

The time limit for making the election is two years after the end of the degrouping company's accounting period in which the section 179 gain was deemed to accrue. In Example 1, the gain accrued on 1 July 2002. This date falls into the year ended 30 June 2003. Therefore, the time limit within which Gallagher Ltd and Ingram Ltd must make their joint election is 30 June 2005.

Any payment made in connection with the reallocation of a gain under section 179A is disregarded for corporation tax purposes, provided that it does not exceed the amount of the reallocated gain.

This new provision has effect for companies leaving groups on or after 1 April 2002.

Rollover relief and degrouping gains

The Revenue has always insisted that it is not possible to roll over a gain arising under section 179, even if it relates to a qualifying asset. This argument was based on the wording of section 152(1) which starts as follows:

A section 179 gain arises because an asset is deemed to have been sold and immediately reacquired by the company leaving the group. Since it is the same asset which is being acquired by that company, it follows that the sale proceeds are not being applied in the acquisition of 'other' assets, as required by the legislation.

At long last, the Government has decided to rectify this anomaly. In the case of companies leaving groups on or after 1 April 2002, the rollover relief provisions have been extended to take in degrouping gains. These new rules are found in section 179B of, and Schedule 7AB to, the Taxation of Chargeable Gains Act 1992.

In order for the new relief to apply, the following conditions must be satisfied (using Example 2):

• Best Ltd must have been carrying on a trade at the time of the intra-group asset transfer.
• The property which was transferred to Atkinson Ltd must have been used for the purposes of Best Ltd's trade.
• An amount equal to the deemed sale consideration of the property must have been reinvested in one or more new assets by Atkinson Ltd in order for full rollover relief to be available.
• The new asset must be taken into use for the purposes of Atkinson Ltd's trade.
• Both the old and the new assets must be within the classes set out in section 155, Taxation of Chargeable Gains Act 1992.
• Atkinson Ltd must make a claim for the relief.

Given that these conditions are satisfied, the normal rollover relief consequences follow. That is to say:

• Atkinson Ltd is treated as having disposed of the premises acquired from Best Ltd at such amount that neither gain nor loss arises.
• The acquisition cost of Atkinson Ltd's new premises is reduced from £500,000 to £225,000.
• But the acquisition cost of the property which was subject to the section 179 charge in Atkinson Ltd's hands is not reduced, otherwise there would be an element of double counting.

The period for reinvestment runs from 12 months before, to three years after, the time when the section 179 charge accrues. If appropriate, a partial rollover relief claim can be made where the full amount is not reinvested. Also, the special rules in section 153A have been modified to allow a company to make a provisional claim for relief in its CT600 for the year in which the section 179 gain accrues.

There have been changes to section 175 which applies rollover relief to capital gains groups. The overall effect of these changes is that, where (using Example 2), Atkinson Ltd is a member of a group when the section 179 charge arises and another member of the group reinvests an amount equal to the deemed sale consideration, that other company can make a claim for rollover relief.

A practical problem

One practical problem with the new section 179 rules concerns the interaction between sections 179A and 179B. A simple illustration makes the point (see Example 3).

Robert Jamieson is a partner in Mercer & Hole in London where he can be contacted on 020 7353 1597. He is a past president of The Chartered Institute of Taxation.

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