Caveat Emptor

In the fourth of a series of articles by Burges Salmon [see third] relating to the sale of shares in private companies, Nigel Popplewell FTII discusses some stamp duty issues.

This article looks, in particular, at stamp duty on asset sales and seeks to illustrate some of the principles using examples of the transactions with which I have been involved recently. The final article in this series, scheduled for publication in two weeks' time, will look at VAT matters relevant to asset sales.

Stamp duty is an increasingly important factor in deciding whether a purchaser buys assets or shares. Securitising assets (by hiving them down to a wholly owned subsidiary) might be considered since the sale of those shares would only attract duty at 0.5 per cent whereas the sale of the assets would have attracted duty at four per cent. The stamp duty ramifications of this are discussed in more detail below. However, the section 179, Taxation of Chargeable Gains Act 1992 degrouping charge, discussed in some detail in Andrew Evans article 'Commercial Tax Planning' published in Taxation, 9 August 2001 at pages 473 to 476, must also be borne in mind.

Asset sales

Contracts for the sale of assets are generally stampable by virtue of paragraph 7 of Schedule 13 to the Finance Act 1999. Most advisers are aware of Stamps Form 22 which must be completed by the purchaser or its authorised representative, following a purchase of assets. It is often useful to go through this form before a transaction, to work out on which side of it certain assets fall and the extent to which duty is payable. Where the value of the dutiable property is less than £60,000/£250,000/£500,000, an appropriate certificate of value can be included. Where the consideration is not ascertainable, or is delayed or deferred, the stamp duty treatment is as set out in paragraphs 4.293 to 4.318 of the Inland Revenue Stamp Duty Manual.

Useful reading

Incidentally, the manual is an extremely useful publication and is available in electronic form. I had always taken a view, on the basis of section 14(4), Stamp Act 1891, that where a non-United Kingdom company purchases assets from another non-United Kingdom company, but consideration for that acquisition is the issue of shares by the vendor's United Kingdom parent to the vendor, that the contract was stampable. It related to something which had to be done in the United Kingdom (the issue of shares). This was the case even though the contract may have been executed and kept offshore. The problem is that in order for the shares to be validly issued, Company Form 88(2) needs to be submitted to Companies House accompanied by the duly stamped contract. This cannot be accomplished if the contract is offshore.

Imagine my surprise, therefore, when thumbing through the manual, I came across paragraphs 4.199 to 4.201. These say (in essence) that in the circumstances I have described above (or rather where foreign shares are transferred in consideration for the issue of shares in the United Kingdom company), and the transfer document is signed and kept abroad, the agreement for the transfer (or Form 88(3)) should be adjudicated as not chargeable with any duty.

The Stamp Office confirmed that this was the case, and also that it applies (or at least the Stamp Office was prepared to accept that it did in our circumstances) where assets are transferred.

Furthermore, contrary to many other Revenue and Customs departments, the Stamp Office (at least here in Bristol) is quite prepared to give informal (but written) pre-transaction rulings where stamp duty legislation and practice is somewhat unclear. Everyone accepts that such rulings are not binding, but they have the huge advantage of giving greater commercial certainty to commercial deals.

Mitigation of stamp duty

There are a number of ways of mitigating stamp duty including the following.

No written contract

No written contract relies on the principle set out in Carlill v Carbolic Smoke Ball Company [1892] 2QB 484. In essence, the contract is drafted in exactly the same way as if it is going to be signed by both parties. Thus for a substantial deal there is a 40 or 50 page asset sale agreement negotiated and (it is to be hoped) concluded. That is then converted into a memorandum of offer, which comprises the terms of an offer which the vendor makes the purchaser. At the same time the vendor writes a letter to the purchaser explaining that he is offering the purchaser the opportunity of buying the assets on the terms of the enclosed memorandum and that offer can be accepted by (for example) paying the agreed price within 30 days, to a specified bank account. The purchaser then pays the price and the contract has been successfully concluded without generating a stampable document. It is extremely important that no such document is generated subsequently. Schemes like this have been used to transfer assets (such as intellectual property) where conveyances of real property or stock transfer forms have not been required.

Since the introduction of the intellectual property exemption in section 129, Finance Act 2000, these arrangements are less necessary where the assets comprise intellectual property. However, where there are other assets (a substantial amount of non intellectual property goodwill, for example) they are well worth considering.

Intellectual property exemption

Section 129 is largely self-explanatory. It is often suggested that goodwill associated with that intellectual property also benefits from stamp duty exemption, but there is no statement of practice yet published. In the cases with which I have been involved, we have written to the Stamp Office seeking confirmation that this is indeed the policy, which has been readily forthcoming.

Offshore documents

Execution and retention of documents offshore is the crucial element of one of a current stamp duty planning technique in relation to the transfer of real property. The scheme works by stripping out the legal title into a subsidiary, transferring the subsidiary to the purchaser for £1 and then contracting to convey the equitable title for consideration, that contract being executed and kept overseas. All the consideration passes under the contract. In a recent deal the purchasers not only wanted to use a written offer and acceptance by conduct (the assets were largely intangible) but also have the documents kept offshore, just in case the documents were treated as a conveyance on sale. This belt and braces approach, suggested at the last minute, did not find much favour with my client and was ultimately rejected. However, it did illustrate one of the problems of keeping documents offshore where there is a transfer of a going concern indemnity.

Changing taxes for a moment, it is usual where business assets are sold in circumstances where the assets comprise a business, transferred as a going concern for VAT purposes, for the parties to agree to treat the transaction as being a transfer of a going concern, but if it transpires that it is not, the purchaser agrees to indemnify the vendor for the VAT due.

This indemnity is only as good as the person giving it, and one of the problems is enforcing on the basis of a contract which is offshore. It may be of no comfort to the vendor that he has a counterpart since, by virtue of paragraph 19 of Schedule 13 to the Finance Act 1999, a counterpart is only liable to £5 duty if the full and proper duty has been paid on the original of which it is the duplicate or counterpart. While it might be possible to persuade the Stamp Office to stamp the vendor's document which describes itself as a counterpart, with £5 duty, it is a high risk strategy. The Stamp Office might stamp it as an original, no matter how it is described. However, by virtue of section 14(4), Stamp Act 1891, to enforce an indemnity to repay the VAT in circumstances where the transaction is treated as a VATable supply, the vendor might have to pay full duty which would otherwise be payable by the purchaser.

Although I have not seen the point taken in practice, given the fact that executing documents offshore saves the purchaser the duty, this is a risk that a vendor should not accept unless he is going to share in a substantial amount of the stamp duty saving.

Securitisation

As mentioned earlier, a straightforward stamp saving scheme would be to transfer the assets down to a subsidiary company and sell the shares in that company thus reducing the duty payable from four per cent to 0.5 per cent. Apart from the degrouping charge, there is also a problem on the hive down. Most readers will be aware that where assets are transferred between members of a 75 per cent group, and the appropriate letter giving details is submitted with the application for adjudication, no duty is payable. However, there are two important circumstances where, notwithstanding the group arrangements, this form of group relief will be denied. These are found in section 27(3), Finance Act 1967 (there is similar relief and restrictions thereon, where leases are granted between companies in a 75 per cent group, in section 151, Finance Act 1995).

The restrictions in section 27(3), Finance Act 1967 deny relief where (simply stated), the instrument effecting the intra group transaction was executed 'in pursuance of or in connection with an arrangement' and either (a) any consideration for the intra group transfer is provided or received directly or (b) indirectly by an unassociated entity, or (and the wording here is important) 'the transferor and the transferee were to cease to be associated within the meaning of the said section 42, Finance Act 1930 by reason of the transferor of a third body corporate ceasing to be the transferee's parent within the meaning of the said section 42'.

If a hive down occurs prior to an onward sale, then it is almost inevitable that this restriction will bite and there will be no group relief (see also Statement of Practice 3/98). This means that there will be four per cent duty (subject to what it said below) on the hive down and a further 0.5 per cent duty on the sale of the shares; which is not much of a result.

Section 76, Finance Act 1986 often comes to the rescue. There is no motive test for the application of this section (unlike sections 75 and 77, Finance Act 1986) and all that is required is a transfer of an undertaking between two United Kingdom companies, the recipient company paying by the issue of shares (non-redeemable) and nothing else other than cash up to ten per cent of the value of those shares or (and this is helpful) the assumption or discharge of debt. If the conditions are satisfied, the rate of duty is 0.5 per cent rather than four per cent.

Thus (absent section 179 problems) the rate of duty can be reduced from four per cent to one per cent simply by hiving the assets down to subco and paying for the transfer by issuing shares. There is 0.5 per cent duty on that. The shares are then transferred to the purchaser and there is a second 0.5 per cent hit. The hive down must be of an undertaking (and as to this see paragraph 6.198 of the Stamp Office Manual). It is also likely to be a transfer of a going concern for VAT purposes. Watch out if it is not, since there will be no cash generated by this transaction.

This scheme could be finely honed in one of two ways, either by using bearer shares or by the purchaser setting up the new subco.

Firstly, bearer shares might be used to reduce the duty on the sale of the sub-co to the purchaser. The stamp duty provisions relating to bearer shares can be found in Schedule 15 to the Finance Act 1999. Since bearer shares are transferred by delivery, it is difficult to levy stamp duty on transfer since no instrument is required. Instead, stamp duty is charged at 1.5 per cent of the market value of the stock on its issue. Market value is deemed to be the value of the stock immediately after its issue (paragraph 7(3)(b) of Schedule 15) for unlisted securities. Thus, if the subsidiary company is set up in the first place with 100 bearer shares, and that company owns no assets, 1.5 per cent of their market value is pretty low.

A section 76 scheme can then be adopted, the subsidiary company issuing non-redeemable shares to its parent in consideration for the hive-down assets. These shares could be odd (i.e. have deferred rights to keep their value low), or any value could be stripped out of them and shifted into the bearer shares. The bearer shares are transferred by delivery and the cash changes hands. The ordinary shares are transferred using a stock transfer form, for £1 (which would be their effective market values. Thus, although there will be a 0.5 per cent rate on the hive-down, there will be no stamp duty on the subsequent sale, all the consideration being paid for the bearer shares.

Purchaser securitisation

However, in these circumstances there is still the section 179 charge lurking in the wings. This can be avoided if the purchaser sets up the subco rather than the vendor; there will still be a capital gains liability under this alternative method but it will be on the vendor which will normally be the more sensible arrangement.

The assets are then bought by the purchaser's subco for a mixture of shares and the discharge of debt, and duty under section 76 is paid at 0.5 per cent. Again, this should be a transfer of a going concern for VAT purposes. The problem is that while a section 179 charge will be avoided (subco is never a member of the vendor's group and therefore never de-groups), both the buyer and the seller will want the shares issued to the vendor bought-in by the purchaser. Indeed, it is at this stage that the cash will change hands and duty will be payable at 0.5 per cent. It is not possible (see Crane Freuhauf [1975] All ER 429) to 'pre-wire' the share buy-in since the shares will never have been issued for section 76 purposes to the vendor. Instead, a call option is put in place enabling the purchaser to buy in the shares of its subsidiary company for the balance of the purchase price left over after the discharge of debt.

In other words, if the purchase price has been agreed at £15 million and, under the section 76 asset buy-in, shares to the value of £10 million have been issued to the seller and £5 million of its debts have been discharged, then the purchaser will buy those shares in at £10 million. The vendor will thus have benefited by having £5 million of its debt discharged and had £10 million in cash. The purchaser will have paid £15 million, £10 million in cash for the shares (duty at 0.5 per cent) and £5 million worth of debt discharge.

It will be appreciated that if the consideration for the asset purchase is all in subsidiary company shares, there will effectively (in the circumstances given above) be two lots of 0.5 per cent duty charged on £15 million. Under the section 76 scheme, the second lot under the share buy-in.

If, however, at the other extreme the consideration for the section 76 buy-in is the assumption of discharge of £15 million of debt, then while there will be a 0.5 per cent duty on the section 76 buy-in, the value of the share (which need not have them any rights and can in any event be swamped by the buyer's shares in its subsidiary) can be bought back for £1. In these circumstances, there is only one 0.5 per cent duty here on £15 million and the charge under section 179, Taxation of Chargeable Gains Act 1992 is avoided.

Nigel Popplewell FTII is a partner at Burges Salmon; he can be contacted on 0117 902 2782.

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