A merger typically involves companies or groups transferring the shares in one or more subsidiaries to another company in exchange for shares. Groups making disposals of subsidiaries, may be eligible for the substantial shareholding exemption, provided the following conditions apply:
- Substantial shareholding
The investing company must hold not less than 10% of the target company’s ordinary share capital, should be beneficially entitled to not less than 10% of the profits available to equity holders and 10% of assets available to equity holders upon the winding up of the company.
- Minimum holding period
The investing company must have held a substantial shareholding throughout a continuous twelve month period beginning not more than six years before the disposal takes places.
- The investing company
Effective 1 April 2017, conditions relating to investing company has been removed. Prior to which, in order to qualify for the exemption the investing company must be a sole trading company or a holding company of a qualifying trading group.
- Target company
The target company must be a trading company or the holding company of a trading group, and the condition must be met throughout the minimum holding period and up to the point of disposal. Effective 1 April 2017, the requirement of the target company to continue to undertake trading activities post disposal has been removed.
- Trading activities
There should not be substantial extent of activities other than trading activities, and this is defined to mean not more than 20% of the company’s activities. This can be measured in relation to the company’s assets, its income or expenditure in terms of time spent on non-trading activities.
Alternatively, Section 135 of TCGA 1992 should apply for rollover relief. Where a subsidiary company leaves a chargeable gains group, a charge to tax may arise under Section 179 of TCGA 1992, for intra-group transfers of capital assets in the previous six years. However, there is a relief for certain mergers under Section 181 of TCGA 1992.
The transfer of such shares are however, likely to be subject to stamp duty.
- Exemption for Companies owned by Qualifying Institutional Investors
Effective 1 April 2017, the government has broadened the exemption to cover gains from sale of a substantial shareholding in any company (whether trading or not), provided immediately before the disposal, at least 80% of the ordinary share capital of the disposing company is owned directly or indirectly by ”qualifying institutional investors.”
The exemption would also apply where the shareholding is less than 10% but has an acquisition cost of at least GBP50 million.
Where the percentage is at least 25%, but less than 80%, then the amount of the chargeable gain (or allowable loss) arising is reduced by the proportion held by qualifying institutional investors.
In situations where the consideration for the target company is by way of an issue of shares in the transferor company, shareholders in the target company are entitled to rollover relief. This is set out under Section 135 of TCGA 1992, the shares received in the transferor company will be treated as the same asset as the original shares and the shareholders of the target will not be treated as having made a disposal.
There must be a holding of more than 5% of the transferee company’s shares of any class, and the transaction must be made for bona fide commercial reasons in order for the exemption to apply.
A merger or takeover through a share for share exchange is subject to stamp duty at 0.5% of the value of the shares issued on exchange. In situations where a new company is established in a merger, to make an offer for the shares in both the transferor and transferee entities, the stamp duty is higher. Although it may be possible to structure the transaction so as to obtain stamp duty relief under Section 77 of FA 1986, this is rather difficult to establish in practice, except if a new holding company is placed at the top of the structure. In order to obtain Section 77 relief, it may be advisable not to effect both share exchanges simultaneously, in order for relief to be obtained for the first share exchange.
It is common for take overs to be effected partly by cash, with the remainder through loan notes. Loan notes are a form of deferred payment used which are redeemable at a future date for the remaining proceeds.
Cash considerations received are treated as a chargeable gain for shareholders, and as such, it might be desirable to structure the transaction in a way that a large proportion of the consideration is satisfied through the issuance of loan notes which fall under the reorganization rollover relief provisions set out in Section 135 of TCGA 1992. This allows the taxpayer to defer the liability to chargeable gains until the time when the loan notes are disposed. It may also be possible to phase the disposal of the loan notes over an extended period, in order to utilize more than a year’s annual capital gains tax exemption. Although this is only significant to individual shareholders, it is nonetheless relevant to the acquisitions of private companies.
It is also worth noting that there is a distinction between the tax treatment of qualifying corporate bonds (“QCB”) and non-QCBs. Where the loan notes are QCBs, the seller’s shareholder gain is frozen and held over until the disposal of the loan note, as set out in Section 116 of TCGA 1992.
The GAAR guidance sets out that structuring a transaction to allow the shareholders of the transferee company to accept a consideration as either QCBs or non-QCBs does not trigger the application of the GAAR provided that is a reasonable course of action. It is therefore generally very rare for acquisitions to be structured using non-QCBs for corporates.
A takeover by scheme of arrangement is a statutory procedure whereby a company makes an arrangement with its creditors, and is now established as it offers advantages over contractual takeovers. These schemes are also used to effect mergers when a new holding company is established.
A takeover or merger can be effected through a transfer of shares. Under the transfer scheme, the shares in the target company are transferred to the bidder as consideration for the issue of shares, loan notes or the payment of cash by the bidder for the target’s shares.
Prior to 4 March 2015, takeover or merger could also be effected through a cancellation. Under the cancellation scheme, the shares in the target company are cancelled and the reserves created on cancellation contribute towards the new shares which are issued to the bidder, which is the consideration to the target’s shareholders. A cancellation scheme involves a reduction of capital. The cancellation scheme offered significant tax advantages as there was no stamp duty on the cancellation or issue of new shares, whereas stamp duty of 0.5% is payable on a transfer scheme. However, effective 4 March 2015, a company takeover may no longer be effected through a cancelation scheme of arrangement. Instead, companies effecting a takeover or merger must now use a transfer scheme of arrangement or a contractual offer, on which stamp tax on shares is payable (0.5%).
Rollover relief on chargeable gains is available for shareholders involved in a scheme of arrangement. Section 135 of TCGA 1992 the rollover relief applies under a transfer scheme, and the rollover into shares and loan notes are available under Section 136 of TCGA 1992. There may be cases where it is necessary to have a part cancellation and part transfer scheme, such as where a loan note alternative is offered for cash, a transfer scheme may be necessary for the loan note rollover. Additionally, in order to meet the requirements of Section 136 of TCGA 1992, it may be necessary to structure the target shares into separate classes to ensure to ensure the entitlement of the relevant shareholders to acquire the shares in the bidder, is the same as any person holding such shares.
Debt restructuring can involve the conversion of debt to equity, debt cancellations or debt buy-back, and the treatment of these transactions is governed by the loan relationship rules.
Debt to equity conversions
Although the issuance of shares to satisfy debt is a common restructuring tool, under the loan relationship rules, it is taxable. However, if the amortised costs basis of accounting is followed, as is the case with most companies, and the release of the debt is in consideration for the issuance of shares which form part of the ordinary share capital of the company, a relief under Section 322(4) of CTA 2009 applies.
As such shares may not have the same rights as the existing shares and can be given economic rights reflecting the agreement with the creditors, this could potentially cause tax de-grouping issues if the debt is in a subsidiary company. In such cases, intra-group restructuring issues should be carefully considered so that the parent company ultimately issues the shares.
A debt cancellation generally results in a taxable credit from the debtor company, which applies generally to loan relationships and also to trade debts as set out in Section 94 of CTA 2009. Although there are reliefs for companies under the formal insolvency process, but not for companies under normal trading conditions.
Debt buyback is a common restructuring tool where the company repurchases some or all of its debt at a discount. A buyback at a discount is accorded the same treatment as a cancellation, where the release gives rise to a taxable credit.
There are limited exceptions to the rule, described as “corporate rescue” which applies where:
- the debt has been acquired under arm’s length terms;
- there is a change in ownership of the debtor company in the period beginning one year before and ending 30 days before the debt buyback;
- if not for the change in ownership, it is reasonable to assume that the debtor company would in twelve months, have been in insolvent liquidation; and
- if not for the change in ownership, the debt buyback would not have been made.
Limited exceptions also apply for debt-for-debt swaps (where the value is the same) and debt-for-equity transactions.
Funds can be raised through share issues, either through a rights issue, an open offer, a placing or a combination of methods. Broadly, the issuance of shares is not a disposal for capital gains purposes and does not constitute a distribution for tax purposes.
In relation to rights issues, the acquisition of a rights issue does not constitute a taxable distribution in the hands of the shareholder, as it brings the shareholder within the capital gains tax share reorganization rules of Sections 126 to 131 of TCGA 1992. The aggregate of the existing shares and the shares acquired in the rights issue will be treated as the same asset, and acquired at the same time as the original shares. The consideration paid for the new shares will be added to the base cost, and indexation of the new shares acquired will run from the date of the payment. Where the issue is deeply discounted, it will be necessary to determine if this is within the share reorganisation rules. If they are not within the share reorganization rules, the acquisition of shares at a discount may involve the capital distribution and part disposal within Section 122 of TCGA 1992.
Stamp duty liability does not arise if bearer shares are not issued and the shares are not issued into a depositary or clearance system. Any subsequent disposal of the new holdings will give rise to stamp duty.
Where the option for the rights is sold, this is deemed a capital distribution which is subject to tax under Sections 122 and 123 of TCGA 1992. The disposal of the rights will constitute a disposal of the original holding unless the amount is small – this is defined as 5% of the value of the shareholding or less than £3,000.
In situations where the shareholder allows the rights to lapse, this will constitute a capital distribution and be taxed similar to that of a disposal.
As rights issues also frequently give rise to fractional entitlements, the sale of these fractional entitlements also constitute a capital distribution, which is likely to be small. The amount of the fractional entitlement will be deducted from the carried-forward base of the new holding.
Open offers of new shares to existing shareholders is unlikely to qualify as a re-organisation within Section 126 but HMRC will treat it as a reorganization in the same way as a rights issue to the extent that the shareholder acquires the shares up to his pro-rata share of the shares on offer. Shares over and above the pro-rata share will be treated as normal acquisitions and taxed accordingly.
Placing of shares
Where shares are issued to certain subscribers without being offered pro-rata to existing shareholders, this is treated as an acquisition of new holdings by the place.
Cash box structures
Where the cash box structure is used (issue of shares for non cash-consideration to avoid the prohibition from issuing securities for cash without first making a formal pre-emptive offer to existing shareholders), in order to enable a UK plc to raise equity for an acquisition.
This generally involves the UK PLC owning the entire share capital of the Jersey special purpose vehicle and the Jersey company will be resident in the UK. As it will be treated as a non-resident in Jersey for tax purposes, it is tax neutral from a Jersey perspective as there is no capital gains tax, corporation tax, stamp duty, VAT or withholding tax payable in Jersey in respect of the issue, transfer or redemption of shares in the Jersey company.
As the register of members is kept in Jersey, stock transfer forms are executed in Jersey which ensures that there is no UK stamp duty on the transfer of shares.