Meeting Points

RICHARD CURTIS offers salient points from a Butterworths Tolley conference on corporate tax.

Financial instruments

Susan Ball of Clyde & Co gave an update of the new rules on loan relationships, derivative contracts and foreign exchange gains and losses. The separate rules on foreign exchange gains and losses have been repealed and, with effect for accounting periods beginning on or after 1 October 2002, such items are included within the rules on derivative contracts and loan relationships.

Susan Ball did warn that the scope of the provisions relating to options, futures and contracts for differences was drawn very wide. Options are not defined as such and contracts for differences are very widely defined and, for example, the definition of 'future' in paragraph 12(6) of Schedule 26 to the Finance Act 2002 could potentially cover any contract that is not completed on the same day as it is agreed. The scope is therefore limited by accounting tests in paragraph 3 and 'underlying subject matter' tests in paragraph 4.

Bad debt anti-avoidance

Susan Ball pointed out that if there was no entitlement to bad debt relief under the rules in Schedule 9 to the Finance Act 1996 because companies were connected, then relief could not now be claimed if there was no connection under the new rules. Watch out for changes in accounting policies that might mean that relief is now to be claimed in respect of an earlier debt. The Revenue may take the line that the bad debt should have been recognised earlier when there would not have been an entitlement to relief.

Degrouping under section 179

Alun James explained that the substantial shareholdings exemption applies to gains that would fall within the 'degrouping' charge of section 179, Taxation of Chargeable Gains Act 1992. Generally, the effect is to move the deemed disposal of the shares from the time of the intra-group transfer to immediately before the company leaves the group. This has the effect of rebasing the value of the shares at that 'departure' point, rather than to the earlier transfer.

Corporation tax self-assessment enquiries

Stephen Cramm of PriceWaterhouseCoopers reviewed the Revenue's current approach to corporation tax self-assessment enquiries, especially those originating from its Large Business Offices. These offices have industry specialists and can draw upon support from Special Investigations Section, Special Compliance Office and head office specialists.

The new approach, which was set out in the Revenue's Review of Links with Business, envisages a partnership between business and the Revenue. The Revenue's 'case director' will manage the relationship between the two sides to agree the co-ordination of enquiries, clearances, advice, filing of year-end returns, identification of tax risks, etc. Despite this new approach, PriceWaterhouseCooper's surveys showed that the subjects of recent corporation tax enquiries remained similar to those previously.

But, does the Revenue have a dilemma between trying to achieve a role as a 'trusted adviser', who may then become an opponent in an enquiry scenario? Stephen Cramm recommended that corporates thoroughly review the perceived advantages and disadvantages before engaging with the Revenue's 'newer approach'. Although it may allow corporates to put pressure on the Revenue to bring old and unresolved issues up to date, is this really 'enabling', or is it a disguise that will allow the Revenue to continue to do what it has always done?

Bad debt relief

Susan Ball advised that there is no bad debt relief given for losses that accrue during an accounting period when companies become connected. However, there is generally no clawback of previously relieved bad debt relief between the parties.

This could be relevant if, say, Company A buys its debtor Company B, seeing this as the only way of remedying the situation.

Also, an acquisition discount does not need to be brought into account if the debt is acquired by a creditor company:

• under an arm's length transaction;
• in an accounting period when the parties were not connected; and
• where there was no connection in the period starting four years before and ending twelve months before the acquisition.

Connection test changes

Susan Ball considered that the main changes of the loan relationships provisions in the Finance Act 2002 that will impact on everyday life will be the changes to the connection tests.

These, very broadly, mean that connected parties cannot, for example, claim relief for bad debts and borrowers cannot claim relief for interest on an accruals basis (only a paid basis) unless the creditor is charged to tax on that basis or the interest is paid within twelve months of the end of the accounting period in which it accrues. The connection test (which itself has changed) is based on control. For accounting periods beginning on or after 1 October 2002, control is no longer defined, as it used to be by section 416, Taxes Act 1988, but now comes within section 840.

Section 416 is less flexible in that control is so widely defined. It includes a 'majority of share capital' test, even including fixed rate preference shares. It also includes loan creditors if they are entitled to the greater part of the assets on a winding up.

Susan Ball gave the example of Company A which gives a loan to Company B to ensure a regular supply of widgets for its manufacturing process. Company B pays interest on the loan. But, what if Company B has huge losses and cannot repay the loan and cannot even continue supplying widgets because of having to cut back its operations?

Company A tries to bail out Company B, and the increased loan would give Company A an entitlement to the greater part of the assets on a winding up. Not only does Company A face losing its supply of widgets, but it no longer gets relief for the bad debt because it has become connected under section 416.

Note also that section 416 includes control by a company or 'associates', which is not the case in section 840. But also note that although both the old and the new régime allow the first and last parties in a series of transactions to be linked, even if they are not themselves connected, under the new régime this connection can be traced through individuals and partnerships as well as companies.

PAYE enquiry 'hit list'

Stephen Cramm advised that the 'top ten' pay-as-you-earn enquiry subjects were as follows.

• Termination payments.
• Status.
• Expatriates.
• Entertaining.
• Fuel scale charges.
• Failure to operate the construction industry scheme.
• Personal incidental expenses.
• National Insurance contributions and aggregation.
• Home to work travel.
• Long service awards.

Substantial shareholdings - 'disponors' and 'targets'

Richard Bramwell QC reviewed the 'substantial shareholdings' legislation of Schedule 7AC to TCGA 1992, which, subject to various conditions, relieves from tax the disposals of shares in subsidiaries by corporates.

Although the legislation looks straightforward and is surprisingly free of technical limits (e.g. the target shares may be in a non-resident company and any form of trade will qualify), he warned of various 'traps, nooks and crannies'.

Sole trading companies and members of trading groups qualify for relief as 'disponors' (the company selling the shares).

Qualifying 'target' companies (i.e. those that are being sold) are:

• trading companies;
• holding companies of trading groups; and
• holding companies of trading sub-groups.

So an investment group with a trading subsidiary cannot qualify as a disponor, neither can a holding company of a trading sub-group within an investment group - the entire group must be 'qualifying' before and after the disposal. However, such bodies would qualify as target companies.

Also note that the definition of a group is not the pure definition in section 170, Taxation of Chargeable Gains Act 1992, but is related to that definition, but with the substitution of a 51 per cent shareholding in place of the usual 75 per cent holding.

Substantial shareholdings and the 'look through' rule

Prior share exchanges, reconstructions and demergers can be 'looked through' for the purposes of the new substantial shareholdings legislation.

As a result, Alun James pointed out that earlier periods of shareholding are aggregated with later periods, unless that transfer in that reconstruction, etc. is itself exempt.

Example

• A Ltd has wholly owned X Ltd and Y Ltd for three years.
• A Ltd is reconstructed with X Ltd going to X1 Ltd, and Y Ltd going to Y1 Ltd.
• The substantial shareholdings exemption cannot apply to these transfers under section 139, Taxation of Chargeable Gains Act 1992.
• The subsequent sale of X Ltd after six months qualifies for the exemption.

Substantial shareholdings - pre and post-disposal requirements

The requirement in Schedule 7AC to TCGA 1992 to be a trading company or member of a trading group must be satisfied from the beginning of a relevant twelve-month holding period until the time of disposal, even if this is longer than twelve months. Alun James provided the following example.

Example

• A Ltd owned 100 per cent of B Ltd until six months ago, at which point it then sold 95 per cent of these shares.
• A Ltd now sells the remaining five per cent shareholding.
• A Ltd must satisfy the trading group requirement for the last 18 months if it is to obtain the substantial shareholdings exemption on that five per cent sale.

Alun James also noted that:

• The 'time of disposal' is the date of the transfer rather than the contract, and conditions must be satisfied to the date of transfer.
• If the disponor company has only been formed within the last twelve months, paragraph 18(4) of Schedule 7AC allows it to obtain the exemption if another group company has satisfied the twelve-month condition, then the periods can be aggregated.
• Post-disposal requirements must be satisfied 'immediately' after the disposal, so a subsequent change of status is irrelevant.

The 'activities' test

Alun James noted the importance of trading activity, which must be maintained to a 'substantial' extent. It is understood that the Revenue is to publish an article in its Tax Bulletin which will add some clarification to this subject.

'Substantial' is understood to mean 20 per cent or more of assets, expenses or turnover (i.e. similar to the criteria for trading companies set out in the Tax Bulletin of June 2001) and this must happen in a 'representative period' after the disposal.

Does this mean that if company A Ltd sells one of its four (equally valued) subsidiaries, so that it then has 25 per cent of its assets in cash, that it has a non-trading activity of a 'substantial' extent? According to Alun James, this will not be the case if A Ltd is actively looking to start or invest in a new trade within a reasonably practicable period.

Some other points follow.

• A distribution of excess cash should not of itself mean that the company fails the test, but a distribution should be made in the context of a trading activity.
• If cash reserves have accrued and start to hover around the 20 per cent limit, is the test about to be failed? This might point to a lack of need of cash for trading. The Revenue takes a strict view of what is 'held for business purposes'. Ensure that there are commercial grounds, such as a policy to avoid borrowings or a need to accumulate and hold cash for investment in a new trade, etc.
• Keep independent records of the action being taken to restart trading. In the event of an enquiry, do not simply expect the Revenue to take the proprietor's word.

Extension to the exemption and combating arrangements

Paragraph 3 of Schedule 7AC to TCGA 1992 has several purposes.

• It extends the main substantial shareholdings exemption of paragraph 1 to circumstances where the target company fails the trading requirement at disposal, but satisfies the requirement at a point in the last two years.
• It allows the relief where the disponor company fails the trading test after disposal only because it is in the process of being wound up.
• It prevents an unallowable loss being turned into an allowable loss by making the target fail the trading requirement at the time of disposal.

But for those who think that there may be some scope for using the exemption to 'smuggle' unrealised gains and untaxed profits out of groups, Alun James warned that the provisions of paragraph 5 of Schedule 7AC prevent this.

For example, HoldCo's trading subsidiary A1 Ltd owns a property standing at a large gain. HoldCo wishes to sell the property, but not the trade. On 1 April 2002, A1 Ltd is sold intra group at full value to A2. On 1 June 2002, A1's trade is transferred to A3 (not a subsidiary of A2). On 1 January 2003, A2 is sold to an outside purchaser.

The sale on 1 April 2002 is within a section 179, Taxation of Chargeable Gains Act 1992 disposal (the 'degrouping' charge, which applies when a company, that has had an asset transferred to it at 'no gain/no loss under section 171, Taxation of Chargeable Gains Act 1992, leaves the group within six years).

A1 Ltd meets the status requirements for a target at that date and without paragraph 5 the substantial shareholding exemption would apply.

Adrian Shipwright, barrister, of Pump Court Tax Chambers reviewed the new legislation on intangible assets, intellectual property and goodwill, contained in section 83 of, and Schedules 29 and 30 to, the Finance Act 2002.

He started with some basic principles that the legislation only applies for corporation tax purposes and follows accounting treatment.

Adrian Shipwright also pointed out that the rules can overlap with the research and development provisions which, by virtue of paragraphs 82 and 83 of Schedule 29, will take precedence over these provisions.

The new system will be a system of debits and credits chargeable and allowable as income or losses for corporation tax purposes. It will replace the piecemeal legislation that has grown up, but only for intangible fixed assets that were:

• created on or after 1 April 2002;
• acquired by a company from an unrelated party on or after 1 April 2002;
• acquired on or after 1 April 2002 from a company where the asset was a 'chargeable intangible asset'; or
• acquired from an 'intermediary' who acquired the asset on or after 1 April 2002 from a third party, related to the intermediary, but not to the acquiring company at the time of acquisition.

The result of the above rules is to make it difficult for relief to be obtained under the new system for assets in existence before 1 April 2002. Adrian Shipwright noted that there may also be areas of confusion. For example, what was the position regarding a computer program that existed before April 2002, but was updated after that?

There are three main categories of assets (other than 'old assets' and those within the income tax charge) that are specifically excluded from the new régime.

• Assets entirely excluded. These comprise rights over intangible assets, oil licences, financial assets, rights in companies and trusts, and intangible fixed assets that are held for non-commercial purposes.
• Assets excluded except as regards royalties. These include intangible fixed assets that are held for life insurance purposes, film and sound recordings and computer software treated as part of hardware for Financial Reporting Standard 10 purposes.
• Assets excluded to an extent specified, including research and development expenditure and computer software that the company has elected to exclude from the scheme.

Adrian Shipwright did note that paragraph 104 of Schedule 29 does allow the Government to bring finance-leased assets within the new régime at some future date.

The effect of the new intangibles régime

Expenditure on the creation, acquisition, enhancement, protection and maintenance of qualifying intangible assets, including abortive expenditure, will be eligible for tax relief from 1 April 2002, broadly in line with its accounting treatment. Adrian Shipwright also explained that profits (or losses) on the disposal of such assets, e.g. goodwill, will be brought into account as Schedule D, Case VI income. This should limit the adjustments that will be required to the company's tax computation, largely to claims to rollover relief to defer the tax liability.

One qualification to the accounting treatment mentioned above is that, on election within two years after the end of the accounting period in which the asset is created or acquired, the company may write down the asset at a fixed rate of 4 per cent (paragraphs 10 and 11).

Groups and related parties

Where assets are transferred intra-group, Adrian Shipwright explained that a 'stand in shoes' approach will generally be adopted, so that the acquiring company will inherit the written down value and tax history of the asset.

If the transfer takes place at other than book value, the Revenue says that normal tax treatment will only continue to apply if the change in value would have been recognised as a revaluation or impairment loss if the asset had not been transferred. In cases of other related party transfers, this will be 'treated for all the purposes of the Taxes Acts (as regards both the transferor and the transferee) as being at market value'. Adrian Shipwright warned that this may lead to an unexpected tax charge.

Safeguards with intangibles

The Revenue will protect its interest under the intangibles régime in various ways, including the anti-avoidance measures in paragraphs 5 and 11 of Schedule 29 which counter arrangements to convert pre-commencement assets into new régime assets (paragraph 5) and to obtain or enhance debits that would not otherwise be due or avoid or reduce credits (paragraph 11).

Paragraph 5 refers to 'correct accounts', which is the Generally Accepted Accounting Practice definition. Adrian Shipwright suggested that this could cause problems, especially if they have a Companies Act certificate. The company's accounting policies and principles should be reviewed to ensure that accounts do not fall foul of this provision, with the Revenue then arguing that the accounts are wrong, should have a different result and putting the accountant 'on the defensive'.

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