CG48510 - Value shifting: Corporation Tax anti-avoidance rule for disposals of shares or securities from 19 July 2011: background
1977 saw the introduction of the general value shifting rule in TCGA92/S30. This does not feature a tax avoidance motive test and, in order to prevent double taxation within a group context, the rule did not apply to the disposal by one company of shares in another company where the reduction in value resulted from the payment of a dividend or from certain asset transfers within a group.
Exploitation of the exclusion, principally in the form of the “drain out dividend scheme” (described below) led to the value shifting rule in TCGA92/S30 being extended to group transactions in 1989 but subject to detailed conditions set out in TCGA92/S31 - TCGA92/S34. Further exploitation led to the introduction of TCGA92/31A in 1999.
A simplification review of the capital gains rules for groups of companies was announced in the 2007 pre-budget report and the subsequent consultation process identified the value shifting rule as it applies in the group context as an area of legislation that was seen as excessively complex.
The new rule is based on a simple tax advantage motive test that addresses tax driven transactions, and shares many features with the targeted anti-avoidance rules for corporate capital losses introduced in FA05.
Example of the drain out dividend scheme
The target company Q has a capital gains base cost of £20m and owns a single asset now worth £70m. Vendor company P wishes to sell Q and the following initial steps are undertaken:
Q acquires a newly incorporated 100 per cent subsidiary R. R borrows £70M from P and uses the funds to buy the asset from Q at its market value of £70M. This sale is at no gain/no loss for capital gains purposes but Q has made an accounting profit of £50M which is available for distribution. Q pays the £50M as a dividend to P. The dividend is said to be tax free in the hands of P (for the purposes of the revised TCGA92/S31, that would depend on the provisions of Part 9A Corporation Tax Act 2009).
Following the payment of the dividend Q is worth £20M. Q’s assets are cash £20M and its shares in R, but the value of Q’s shares in R is negligible. This is because the value of the asset acquired by R from Q is matched by an equivalent borrowing. P can now sell the shares in Q to the third party purchaser at market value £20M. No degrouping charge arises as a result of the asset transfer because the “associated companies” exception in TCGA92/S179(2)-(2ZB) applies. See CG45435.
P will receive the full value of the asset of £70M from the sale: £20M as direct consideration on the share disposal and a further £50M in the form of a dividend. It will also receive £70m when R repays the loan. If the purchaser provides the funds to repay the loan by way of additional equity then it may obtain a capital gains deduction for the full value of on any subsequent sale.
