House of Commons - Explanatory Note
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This change is in taxpayers' favour in principle and may benefit some in practice. But the numbers affected and the amounts involved are likely to be small.

Change 20: Share loss relief and community investment tax relief: omit the words "for full consideration": clauses 131 and 361

This change deletes the words "for full consideration" which qualify "by way of a bargain made at arm's length". It removes words which are not in practice applied to impose any additional requirement and creates consistency, for individuals, between the provisions relating to withdrawal or reduction of EIS relief, VCT relief and CITR.

There are three places in the Tax Acts where the words "by way of a bargain made at arm's length" are qualified by the words "for full consideration". These are:

for both income tax and corporation tax:

  • section 575(1)(a) of ICTA (relief for losses on unquoted shares in trading companies); and

  • paragraph 29(4)(a) of Schedule 16 to FA 2002 (community investment tax relief);

and for corporation tax only:

  • paragraph 46(2)(a) of Schedule 15 to FA 2000 (the corporate venturing scheme).

Paragraph 46(2)(a) of Schedule 15 to FA 2000 is also applied for the purposes of paragraph 67 of that Schedule by paragraph 67(3).

Section 575(1)(a) of ICTA and paragraph 67 of Schedule 15 to FA 2000 are concerned with the circumstances in which an allowable loss incurred on a disposal of shares may be claimed as a relief in calculating taxable income for income tax or corporation tax purposes.

The phrase "for full consideration" has not caused practical difficulty in relation to claims for relief by individuals under section 574 of ICTA or by companies under section 573 of that Act or paragraph 67 of Schedule 15 to FA 2000.

Case law (Berry v Warnett (1982), 55 TC 92 HL 1 and Bullivant Holdings Limited v CIR (1998), 71 TC 22 ChD 2) confirms that a bargain may be made at arm's length if a full and fair price is paid. Whether the price is full and fair is to be determined by reference to the circumstances of the disposal and it is clear that the price paid may be full and fair notwithstanding that it is substantially below open market value.

1      [1982] STC 396

2      [1998] STC 905

If the words "for full consideration" mean no more than that a full and fair price is paid in the circumstances of the disposal, the words are otiose. If they have independent meaning, this may require that the price paid is not less than market value, if market value is greater than the amount which is a full and fair price in the circumstances of the disposal. But in practice no such requirement is imposed.

Accordingly the words "for full consideration" have been omitted from clause 131(3)(a) in rewriting section 575(1) of ICTA for income tax purposes.

Paragraph 29 of Schedule 16 to FA 2002 and paragraph 46 of Schedule 15 to FA 2000 are concerned with the withdrawal or reduction of tax relief previously obtained. These paragraphs contrast with the only other provisions in the Tax Acts dealing with the withdrawal or reduction of investment reliefs. In those provisions, the words "by way of a bargain made at arm's length" appear without any qualification.

The provisions in the source legislation and the clauses where they are rewritten in this Bill are:

  • section 299(1)(a) and (b) of ICTA (withdrawal or reduction of EIS relief), rewritten as clause 209(2) and (3); and

  • paragraph 3(2) and (3) of Schedule 15B to ICTA (withdrawal or reduction of VCT relief), rewritten as clause 266(2)and (3).

In practice, the provisions for the withdrawal or reduction of CITR are operated on the same basis as the similar provisions relating to EIS relief and VCT relief - see paragraph 7020 of HMRC's Community Investment Tax Relief Manual (CITM 7020). Omitting the words "for full consideration" from clause 361(4)(a) brings the text of all three rewritten income tax provisions into line.

This change is in the taxpayer's favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 21: Share loss relief: transfer of shares between spouses or civil partners: effect of earlier application of clause 135(3) or (4): clause 135

This change introduces into clause 135(3)(a) a reference to A being treated under clause 135(3) or (4) as having subscribed for the shares, in order to deal explicitly with cases of the issue of corresponding bonus shares and sequential transfers of shares between spouses or civil partners.

The cases in question are those involving:

  • corresponding bonus shares which are treated under clause 135(4) as having been subscribed for by A in consideration of money or money's worth (see Change 23); and

  • shares which have been subscribed for by an individual in consideration of money or money's worth and which are treated as subscribed for by A as a result of the operation of clause 135(3) on a previous transfer to A by that individual at a time when that individual was A's spouse or civil partner (whether that individual is B or another).

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 22: Share loss relief: transfer of shares between spouses or civil partners: time at which spouses or civil partners are living together: clause 135

This change makes it explicit that, if shares are transferred between spouses or civil partners, they must be living together at the time of the transfer but need not have been spouses or civil partners at the time of the subscription for the shares.

Section 574(3)(b) of ICTA provides that:

an individual shall be treated as having subscribed for shares if his spouse or civil partner did so and transferred them to him by a transaction inter vivos.

Section 576(5) of ICTA provides that:

"civil partner" refers to one of two civil partners who are living together (construed in accordance with section 282)

"spouse" refers to one of two spouses who are living together (construed in accordance with section 282)

Section 574(3)(b) of ICTA does not provide explicitly that the only time relevant for the purpose of determining whether the transferor and transferee are living together is the time of the transfer. In practice, however, this is how it has been applied.

Clause 135(3)(c) (read with the definitions of "spouse" and "civil partner" in clause 151(1)) makes this explicit. Clause 945, which rewrites section 282 of ICTA, explains the meaning of "living together".

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 23: Share loss relief: corresponding bonus shares: clauses 135 and 151

This change legislates the practice that corresponding bonus shares are qualifying shares for share loss relief.

When shares are issued by way of bonus, they are not issued for consideration. Bonus shares do not, therefore, meet the requirements of section 574(3)(a) of ICTA (rewritten as clause 135(2)) that the individual has subscribed for the shares in consideration of money or money's worth.

In practice, where ordinary shares in the same company, of the same class and carrying the same rights as shares for which an individual has subscribed are issued by way of bonus, claims for relief on the disposal of the shares issued by way of bonus are accepted.

Accordingly, clause 135(4) provides that, where an individual who has subscribed in consideration of money or money's worth for shares in a qualifying trading company is issued with bonus shares in that company which are of the same class and carry the same rights (corresponding bonus shares), the individual is treated as having also subscribed for the corresponding bonus shares in consideration of money or money's worth.

This means that the corresponding bonus shares are shares which have been subscribed for by the individual for the purposes of clause 131(2)(b).

The definitions of bonus shares and corresponding bonus shares are in clause 151(1) and (2).

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 24: Share loss relief: resolution of conflicting provisions: clauses 136 and 145 and Schedule 2 Part 6 (disposals of new shares and relief after an exchange of shares for shares in another company)

This change makes clear that the provisions of clause 136 do not apply to an exchange of shares to which clause 145 applies. It resolves an apparent conflict between section 304A of ICTA, rewritten in clauses 145 and 146, and section 575(2) of ICTA, rewritten in clause 136, which arises from the way in which section 575(2) of that Act achieves its purpose.

Section 575(2) of ICTA is an anti-avoidance provision. Its purpose is to prevent a person from obtaining share loss relief in respect of non-qualifying shares in a company (Oldco) by swapping them for qualifying shares in another company (Newco), except to the extent that the person gives additional consideration for the qualifying shares. For example, the shares in Oldco may not be qualifying shares because they were purchased from another shareholder. This provision has existed since the introduction of share loss relief in 1980.

Section 304A of ICTA was first applied for the purposes of share loss relief as part of the changes to the meaning of "qualifying trading company" made by FA 1998. It deals with the continuity of the requirements to be met by Newco following an exchange of qualifying shares in Oldco for qualifying shares in Newco without change of ownership.

Section 575(2) of ICTA applies to the issue of ordinary shares ("new shares") by Newco in an exchange or scheme of reconstruction within section 135 or 136 of TCGA relating to shares ("old shares") in Oldco. The new shares are in these circumstances "issued in consideration of .. money's worth", that is the transfer or cancellation of the old shares. Accordingly, if Newco is a qualifying trading company, the new shares will be capable of being qualifying shares (see section 574(3)(a) of ICTA rewritten in clause 135(2)). This is the case whether or not the old shares are qualifying shares.

Section 575(2)(a) of ICTA operates to prevent share loss relief being obtained on the disposal of the new shares where the old shares were not themselves qualifying shares by requiring the following assumptions to be made:

  • first, that section 127 of TCGA does not apply to the exchange or scheme of reconstruction, so that there is a disposal of the old shares for the purposes of capital gains tax; and

  • second, that on that assumed disposal an allowable loss would have been incurred for those purposes.

Section 575(2)(a) of ICTA then requires that share loss relief would have been obtainable on the assumed disposal on the basis that it was a disposal by way of a bargain made at arm's length. This is a consequence of the express reference in section 575(2)(a) of ICTA to the individual incurring an allowable loss "in disposing of [the old shares] as mentioned in subsection (1)(a) above". Section 575(1) of ICTA sets out the categories of disposal in respect of which a claim for share loss relief may be made, including in paragraph (a) a disposal "by way of a bargain made at arm's length for full consideration". This requirement is rewritten in clause 131(3)(a). See the commentary on clause 131 and Change 20.

Unless, on the assumptions described, share loss relief would have been obtained on the assumed disposal of the old shares, share loss relief may not be obtained on the disposal of the new shares, except to that extent that any "new consideration" has been given for the new shares (see section 575(2)(b) of ICTA rewritten in clause 136(4) and (5)).

Section 304A of ICTA is one of the provisions applied by section 576(4A) of that Act with modifications for the purposes of defining a qualifying trading company by reference to the requirements of section 293 of ICTA. Section 304A of ICTA has been rewritten with the required modifications in clauses 145 and 146 (see the commentary on those clauses and Change 25).

Section 304A of ICTA relates to an exchange of securities within section 135 of TCGA affecting old shares which are qualifying shares. The type of exchange to which section 304A of ICTA applies is one which involves no change of ultimate ownership. It typically occurs when a new holding company is placed above a previously loss making company as one of the steps in obviating difficulties arising under company law in relation to distributable profits.

The effect of section 304A of ICTA as modified and applied by section 576(4A) of that Act is that, if the exchange meets the requirements of section 304A(1) of ICTA, the new shares are capable of being qualifying shares and the requirements for Newco to be a qualifying trading company are to be applied as if Oldco and Newco were one and the same company. In particular, the unquoted status requirement in section 293(1A) of ICTA (rewritten in clause 143) and the gross assets requirement in section 293(6A) of ICTA (rewritten in clause 142) are to be met only at the time of issue of the old shares by Oldco.

But if the assumptions required by section 575(2)(a) of ICTA are to be applied to an exchange falling within section 304A(1) of that Act, the requirement that the assumed disposal arises by way of a bargain made at arm's length is unlikely to be capable of being met. This would prevent a claim for share loss relief on the disposal of the shares in Newco and make the application of section 304A of ICTA ineffective for the purposes of share loss relief.

This change resolves that apparent conflict by providing in clause 145(3) that nothing in clause 136(2) applies to an exchange falling within clause 145(1).

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 25: Share loss relief: removal of mandatory requirement for pre-clearance of share exchange: clause 145, Schedule 1 (section 576J of ICTA) and Schedule 2 Part 6 (relief after an exchange of shares for shares in another company)

This change removes the requirement in section 304A(1)(f) of ICTA, as applied to sections 573 and 574 of that Act by section 576(4A) of that Act, that a clearance must have been obtained before section 304A of that Act can apply.

Section 304A(1)(f) of ICTA provides that:

before the issue of the new shares the Board have, on the application of the new company or the old company, notified that company that the Board are satisfied that the exchange of shares-

(i)     will be effected for bona fide commercial reasons, and

(ii)     will not form part of any such scheme or arrangements as are mentioned in section 137(1) of the 1992 Act.

Clause 145(1)(e) of this Bill and the new section 576J(1)(e) of ICTA introduced by Schedule 1 replace section 304A(1)(f) of ICTA with a requirement that:

by virtue of section 127 of TCGA 1992 as applied by section 135(3) of that Act, the exchange of shares is not to be treated as involving a disposal of the old shares or an acquisition of the new shares.

These provisions also omit section 304A(8) of ICTA which applies section 138(2) of TCGA for the purposes of section 304A(1)(f) of ICTA.

The mandatory requirement contained in section 304A(1)(f) of ICTA for clearance to be obtained in advance of the issue of the new shares is necessary in the context of a provision which permits EIS income tax relief attributable to shares in a company to continue to be attributed to shares in a new holding company issued under an exchange of shares which meets the other requirements of that subsection.

Where EIS income tax relief is not attributable to the old shares, it is likely that in practice advance clearance will have been sought, and given, under section 138 of TCGA in advance of the exchange of shares. There may, however, be a minority of cases where such a clearance was not sought but, if it had been sought, would have been given. One case in which such a clearance might not have been sought is if no person held more than 5% of the shares in the old company (see section 137(2) of TCGA).

Paragraph 8(1) of Schedule 5B to TCGA which deals with EIS re-investment relief is in similar terms to section 304A(1) of ICTA with the exception of paragraph (f). That paragraph does not require there to be advance clearance but requires that the anti-avoidance provisions of section 137 of TCGA do not apply so as to prevent the "no disposal" treatment under section 127 of that Act applying to the old shares.

Clause 145(1)(e) of this Bill and the new section 576J(1)(e) of ICTA are in similar terms to paragraph 8(1) of Schedule 5B to TCGA, with the result that, in the minority of cases where an advance clearance under section 138 of TCGA has not been sought, share loss relief under Chapter 6 of Part 4 or relief under section 573 of ICTA is not denied solely because of the failure to have obtained such a clearance.

This change is in taxpayers' favour in principle and may benefit some in practice. But the numbers affected and the amounts involved are likely to be small.

Change 26: Share loss relief: restrictions on the amount of relief available: clause 147

This change refines and extends the provision in section 576(1) of ICTA which restricts the amount of share loss relief available in a case where qualifying shares forming part of a holding are disposed of.

Section 576(1) of ICTA provides that, if an individual disposes of qualifying shares forming part of a holding, the amount of relief must not exceed the sums which would be allowed as deductions in computing the allowable loss if the shares had not been part of the holding.

For capital gains tax purposes, where shares are pooled in a section 104 holding (see section 104 of TCGA) or a 1982 holding (see section 109 of TCGA), the total consideration given for all the shares in the pool is averaged across the shares. This means that, when there is a part disposal of shares out of the holding, a proportion of this consideration is deducted in computing the chargeable gain pro-rata to the number of shares disposed of over the total number of shares in the pool. This may result in an allowable loss on the disposal of such shares being greater than it would have been if the shares had not been pooled.

This provision is designed to limit the share loss relief available in such cases to no more than what would have been the amount allowable as a deduction in calculating the loss if the shares had not been pooled. Ignoring incidental costs of acquisition and disposal, this will equate in most cases to the amount subscribed for the shares. It is a general rule, but is of special relevance to the case where some of the shares in the pool are not qualifying shares.

To cater for the abolition of pooling in relation to shares issued on or after 6 April 1998 and the changes in clause 148 described in Change 29, clause 147 refines the circumstances in which the provision applies. The circumstances are:

  • where the qualifying shares disposed of form part of a section 104 holding or a 1982 holding at the time of the disposal or formed part of such a holding at any earlier time (subsections (1) and (2));

  • where both qualifying shares and shares which are not capable of being qualifying shares are acquired on the same day and are treated by virtue of section 105(1)(a) of TCGA for the purposes of capital gains tax as acquired by a single transaction (subsections (3) and (4)); and

  • where the qualifying shares in a company are treated by virtue of section 127 of TCGA for the purposes of capital gains tax as the same asset as other shares in the same company which are not capable of being qualifying shares or as debentures of the same company (subsections (5) and (6)).

The clause has the following effects:

  • Subsections (1) and (2) rewrite the provision in section 576(1) of ICTA with two changes.

  • The first change is that subsection (2) only applies to shares which are pooled in a section 104 holding or a 1982 holding. It requires the allowable deductions for the qualifying shares to be re-calculated as if the qualifying shares did not form part of the section 104 holding or the 1982 holding. But it does not affect the calculation of the allowable deductions in any other way. For example, if there has been an issue of corresponding bonus shares in respect of original qualifying shares, the re-calculated allowable deductions will be apportioned in the usual way across the original shares and the corresponding bonus shares.

  • The second change is that subsection (2) expressly applies if an individual disposes of all the shares in the section 104 holding or the 1982 holding and at some time those shares and other shares which have been disposed of earlier formed part of the same holding (see subsection (1)(b)(ii)). This deals with the effect on the pool allowable cost where the other shares were acquired at a different price from that of the shares now being disposed of. It is a clarification of the scope of the provision in section 576(1) of ICTA.

  • Subsections (3) to (6) are new. They are limited to mixed holdings (see the commentary on clause 148 and Change 27) and deal with the residual situations where the cost of shares which are not within a section 104 holding or a 1982 holding are still averaged. The general provision in subsection (1) is not required for shares which do not form part of a pool. It is only in the case of shares in such a holding that acquisitions and disposals of other shares which at any time formed part of the holding will affect the allowable cost of the qualifying shares disposed of.

  • Subsections (3) and (4) deal with the circumstances where the cost of qualifying shares and shares that are not capable of being qualifying shares acquired on the same day are subject to averaging.

  • Subsections (5) and (6) ensure that the limit is calculated separately in relation to the qualifying shares in the case of a reorganisation, such as a rights issue, involving qualifying shares and shares that are not capable of being qualifying shares or debentures. In those circumstances, the allowable deductions by reference to which the limit is to be calculated in accordance with this subsection are likely to differ from the cost of acquisition of the qualifying shares calculated in accordance with section 129 of TCGA.

Subsection (8) explains what is meant by "shares that are not capable of being qualifying shares" for the purposes not only of this clause but also clause 148. See Change 27 for a detailed explanation of why a mixed holding has been defined in terms of a holding which includes such shares. Subsection (9) extends this meaning for the purposes only of subsection (5) to cover re-organisations involving the issue of shares of a different class.

This change is adverse to some taxpayers in principle and in practice. But the numbers affected and the amounts involved are likely to be small.

Change 27: Share loss relief: meaning of a mixed holding: clause 148

This change substitutes for the meaning of a mixed holding in section 576(1) of ICTA a new definition of a mixed holding.

Section 576(1) of ICTA contains a rule for identifying shares disposed of by a person out of a holding which comprises:

(a)     shares for which he has subscribed ("qualifying shares"); and

(b)     shares which he has acquired otherwise than by subscription.

This distinction has remained unchanged since the introduction of this provision by section 37 of FA 1980. At that time and at the time of its consolidation in 1988 as section 576(1) of ICTA, the wording was adequate to distinguish between shares which would qualify for share loss relief and those which would not.

Following the changes to the definition of qualifying trading company made by FA 1998 and FA 2001, the fact that this is the distinction made by section 576(1) of ICTA has become less evident.

At the time of a disposal of shares to which EIS relief is not attributable from a holding, those or other shares in the holding may be known to be incapable of ever being qualifying shares, even though they were subscribed for. This can be because:

  • the company failed to meet either the gross assets requirement or the unquoted status requirement at the time of issue of the shares; or

  • the company has failed to meet the condition that it has carried on its business wholly or mainly in the United Kingdom in relation to the shares. If the failure in relation to those shares was only during a period that ended more than 12 months before other shares in the holding were issued, it will not cause the other shares to be incapable of being qualifying shares.

Clause 148(1), accordingly, provides that a mixed holding is one which, at the time of the disposal in question, includes shares that are not capable of being qualifying shares and "other shares", that is shares which at that time may or may not qualify for relief on their disposal. Shares to which EIS relief is attributable will always be capable of being qualifying shares and so, for the purpose of determining whether there is a mixed holding, fall into the category of "other shares".

Shares that are not capable of being qualifying shares are defined in clause 147(8) as not only shares to which EIS relief is not attributable acquired otherwise than by subscription, but also such shares in relation to which the gross assets requirement or the unquoted status requirement or the requirement as to the carrying on of business wholly or mainly in the United Kingdom has not been met.

This change is adverse to some taxpayers and favourable to others in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 28: Share loss relief: identification of which shares are disposed of: clause 148

This change legislates the practice that, if the identification rule in section 576(1) of ICTA identifies that some but not all of the qualifying shares in the mixed holding are disposed of, the rule is also applied to determine which of the qualifying shares are disposed of.

It is stated explicitly in clause 148(2)(b) that the rule as amended by Change 27 so applies.

 
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