CHAPTER 31 TRANSFER OF TRADES

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1 CHAPTER 31 TRANSFER OF TRADES This chapter looks at transfers and successions: the rules for transfers of a trade; succession where there is common ownership; reconstruction relief under TCGA Transfer of a trade between companies In the first part of this chapter we will look at the rules that apply on the transfer of a trade between two companies. Assume we have two companies, A Ltd and B Ltd, that are not in a group together. The trade is being transferred, or sold, by A Ltd to B Ltd at market value. This trade represents a collection of assets, which are effectively each being sold for their market value. If A Ltd has no other trading activity, the sale will result in the cessation of A Ltd's trade which will bring to an end an accounting period. In addition, if B Ltd was not trading prior to the acquisition, it will commence trading. Therefore its current accounting period will end and a new accounting period will begin. The disposal of any chargeable assets by A Ltd, for example buildings and old intangible fixed assets (pre 2002), will result in capital gains or losses. Any gains can be rolled over if A Ltd acquires new qualifying assets within 1 year before or 3 years after the transfer. If A Ltd transfers any new intangible fixed assets with the trade, these disposals will result in income gains or losses under the IFA regime. Again, any income gains can be rolled over if A Ltd acquires new intangible fixed assets within 1 year before and 3 years after the transfer. The transfer of A Ltd's plant and machinery at market value will result in balancing adjustments in A Ltd. If A Ltd and B Ltd are connected companies, a joint election can be made to transfer the assets at tax written down value and avoid these balancing adjustments. The election must be made within 2 years of the transfer. Connected for this purpose is where one company controls the other, or the companies are under common control. CAA 2001, s.266 If A Ltd and B Ltd are unconnected, any stock in A Ltd is transferred at a just and reasonable amount agreed between the parties as it has been transferred with other assets. This will result in a trade profit or loss in A Ltd. CTA 2009, s.165 If A Ltd and B Ltd are connected, stock is transferred at market value. A joint election can be made to transfer at the higher of price paid and cost (if both are lower than the market value). Connected has the same definition as above, and a claim must be made within 2 years of the end of the accounting period of cessation of A Ltd. CTA 2009, s.167 Reed Elsevier UK Ltd FA 2014

2 If A Ltd has any trade or capital losses they can be offset against the above profits and gains, and terminal loss relief may be available for any trade losses made in the last 12 months of trade. This would allow A Ltd to carry the losses back 36 months against total profits. Any unutilised losses remain in A Ltd and may therefore be wasted. CTA 2010, s.39 Illustration 1 On cessation of trade, stock which cost 100,000 is transferred to a connected party for 120,000. The open market value of the stock is 150,000. As both the cost and the price received are below the market value, an election is possible under s.167 where we elect to substitute the greater of the price agreed or the original cost in place of market value. In this scenario it will be the price received, which is 120, Successions We will now compare this with the rules that apply on a succession. CTA 2010, s.940a For the succession rules to apply, the trade must have the same persons having 75% ownership of it at some point in the year up to its transfer and within the 2 years after the transfer. CTA 2010, s.941 The succession rules mean that, automatically: The plant and machinery will transfer at tax written down value. CTA 2010, s.948 Trade losses transfer with the trade. No terminal loss relief is therefore available to A Ltd. CTA 2010, s.944 As before, if A Ltd has no other trading activity the sale will result in the cessation of A Ltd's trade, which will bring to an end an accounting period, and B Ltd will commence a new accounting period if it was not already trading. If A Ltd and B Ltd are in a gains group together, chargeable assets will transfer at no gain no loss, and intangible fixed assets will transfer at a tax-neutral value TCGA 1992, s.171; CTA 2009, s.775 If the companies are unconnected, stock will transfer at a just and reasonable amount or if connected, at market value. The election to transfer at higher of price paid and cost is available if they are both lower than market value. Capital losses will remain in A Ltd. If there is a change of ownership that has been preceded by a succession, the carry forward of losses in the new company is restricted by the change of ownership rules. CTA 2010, s.673 For example, suppose that Parent Ltd holds 100% of A Ltd, and A Ltd has brought forward losses. A Ltd transfers its trade to a wholly-owned subsidiary of Parent Ltd, Newco Ltd. Under the successions rules, the losses of A Ltd are transferred with the trade to Newco Ltd. Reed Elsevier UK Ltd FA 2014

3 Parent Ltd then sells Newco Ltd to an unrelated third party, Z Ltd. Under the change of ownership provisions, the losses made and the trade carried on by A Ltd before the transfer of trade, are treated as if they were those of Newco Ltd. Thus, if there is a major change in the nature or conduct of the trade previously carried on by A Ltd within three years either side of the sale of Newco Ltd to Z Ltd, or if there is a considerable revival in a small or negligible trade at any time following the acquisition of Newco Ltd by Z Ltd, the change of ownership provisions will apply to disallow the use by Newco Ltd of losses brought forward from A Ltd. CTA 2010, s.676 Prior to March 2013, there was a loophole in the legislation. Suppose Parent Ltd, rather than transferring A Ltd s trade and assets to Newco Ltd, sold A Ltd directly to Z Ltd. Suppose that Z Ltd had then set up a new subsidiary and transferred A Ltd s trade, including losses, to it. If the new subsidiary had then made a major change in the nature or conduct of its trade, the losses were not restricted under the rules as they stood, so getting around the restriction. For changes in ownership that occur on or after 20 March 2013, the restriction on use of losses applies regardless of whether the change in ownership occurs before or after the transfer of trade, thus effectively closing this loophole Restriction of the trade loss transferred We have just seen that in the event of a succession, the trade losses are automatically transferred to the successor company alongside the trade. However, the loss transferred is restricted if the predecessor's liabilities exceed assets, i.e. A Ltd has been left as an insolvent company, unable to meet its liabilities. CTA 2010, s.945 The liabilities that we take into account are all liabilities which were incurred in connection with the trade, that have been retained by A Ltd. It excludes share capital, share premium, reserves and loan stock. However, if the loan stock is secured on an asset that remains in A Ltd, the value of the asset is reduced by the loan stock. CTA 2010, s.946 The assets we take into account are all assets attributable to the trade which have not been transferred, valued at market value, plus the consideration received from B Ltd. CTA 2010, s.947 Illustration 2 East Midlands Ltd transfers its trade to Alicante Ltd, a company in which it has a 75% holding, for 300,000. A building used in the trade with a market value of 250,000 is retained, along with 100,000 loan stock secured on it and a bank loan of 700,000. East Midlands Ltd has trade losses being carried forward of 900,000. Reed Elsevier UK Ltd FA 2014

4 The liabilities and assets retained are: Assets: Building 250,000 Less: Loan stock secured (100,000) 150,000 Consideration 300, ,000 Liabilities: Bank loan (700,000) Total (250,000) Net Liabilities (250,000) The losses transferred to Alicante Ltd will be 900,000 less 250,000, so 650,000. Example 1 Birmingham Ltd owns 100% of Malaga Ltd. Birmingham Ltd transfers its trade to Malaga Ltd when it has losses of 1,200,000. Malaga Ltd pays 250,000 for the trade. Birmingham Ltd has: Stock 100,000 Debtors 645,000 Cash 40, ,000 Creditors 250,000 Overdraft 500,000 P&L 25,000 Share capital 10, ,000 The cash, stock and overdraft are not transferred. Birmingham Ltd has received an offer of 120,000 for the stock. You are required to calculate how much of the loss will be available to Malaga Ltd Successions and case law Although the legislation is anti avoidance legislation aimed primarily at additional loss relief being claimed by use of terminal loss claims and balancing allowances on capital items, it has been interpreted by many as a means of allowing losses to be bought. Loss buying in this context will normally involve the hive down or across of a trade or part of a trade to a Newco by the vendor, followed by a sale of the Newco to the purchaser. This may then be followed by a further transfer of the trade once Newco is owned by the purchaser. This process will lead to many questions as to whether the requirements of s.940a have been met allowing the losses to be transferred, in particular, has there been Reed Elsevier UK Ltd FA 2014

5 a succession? This will be especially in point where a trade is transferred that is only part of the trade of the transferor, the transferee, or both. Losses can still be transferred with the trade if: CTA 2010, s.951 i. A company ceases to carry on a trade, and another begins to carry on the activities of that trade as part of its trade; or ii. A company ceases to carry on part of a trade, and another company begins to carry on the activities of that part as its trade, or as part of its trade. The legislation does not give any guidance as to what is to be regarded as part of a trade. It does not have to be a separately identified division or branch. Case law gives us some guidance on how the legislation should be applied. The two leading cases are Laycock v Freeman Hardy & Willis Ltd (FHW) and Falmer Jeans v Rodin. In the FHW case, the company had two wholly owned subsidiaries that manufactured boots and shoes, and these were sold to FHW who sold them in their retail shops. FHW acquired the goodwill of its two subsidiary companies together with their assets and staff. They continued to manufacture the same class of boots and shoes from the same factories, which were then sold to the shops. The company kept separate accounting records for the two factories treating them as separate concerns. It was stated that it was not necessary for the business to be identical in every respect after the succession. A successor may for example take over a business of fifty shops; he may choose to shut up some of those shops; he may make alterations to the goods that he sells; changes of that kind may or may not be substantial so it is difficult to say if a succession has taken place. It was found that the trade previously carried on by the subsidiaries no longer existed following the transfer to FHW. The trade was identified as one of a manufacturing wholesaler. Although the manufacturing continued after the transfer, the wholesale trade in the manufactured products ceased. The above case was distinguished from the Falmer Jeans case. In summary, FM manufactured garments for FJ, a fellow subsidiary company. FJ sold jeans and other casual clothing. FM made the clothes from material supplied by FJ. The finished garments were not sold to FJ, rather FM's services were charged out to FJ at cost plus a margin. The margin represented a commercial return at all times. FM started to make losses, and on the advice of the accountants, the trade and assets of FM were transferred to FJ. FJ kept separate accounts for the activities formerly carried on by FM. It was stated that not all the activities of a trade need to be carried on following the transfer, but the activities must be sufficient for them to be treated as a separate trade. It was held that FJ began to carry on the activities of FM, although FJ no longer made up cloth to the customer s specifications but rather to its own specifications. It still continued to carry on the activities it had carried out prior to the merger, namely buying cloth and providing the specifications. FJ did not charge its customers separately for the manufacture of the garments, however its customers Reed Elsevier UK Ltd FA 2014

6 continued to pay for the manufacture of the garments in the purchase price they paid. Where part of a trade is transferred, or a trade is merged with an existing trade, the principles of streaming will be in point, which means that the successor is only allowed loss relief for the losses belonging to the trade or part-trade which was transferred from the predecessor, and that the transferred losses are only allowed against the profits from the trade or part-trade acquired from the predecessor. However these streaming rules only apply to the losses transferred under s.944 they do not affect any existing losses in the successor nor do they affect losses incurred after the succession. The legislation provides that any apportionment required to stream profits and losses should be done on a basis that is just and reasonable Reconstructions involving the transfer of a business There are special rules that apply to the transfer of chargeable assets when there is a scheme of reconstruction. TCGA 1992, s.136 & s.139 A scheme of reconstruction is where: TCGA 1992, Sch 5AA Ordinary shares in the successor company are issued to the shareholders of another company and no-one else; The shares are issued in proportion to their shareholdings in that other company; and The effect is that the business of the original company is carried on by the successor company; or The scheme is carried out in pursuance of a compromise or arrangement under Part 26 of the Companies Act So, let's consider the position of a trade or business transfer. A Ltd transfers a trade or business to B Ltd, and consideration in the form of shares in B Ltd is given directly to the shareholders of A Ltd rather than to A Ltd thus B Ltd issues shares to the existing shareholders of A Ltd. The rules apply where: TCGA 1992, s.139 a scheme of reconstruction involves the transfer of a business, or part of a business, the transferor and transferee companies are either UK resident, or the assets are chargeable assets in relation to the company, and the transferor receives no part of the consideration for the transfer. The reconstruction must be for bona fide commercial reasons, and not for tax avoidance purposes. If these conditions are met, the assets transfer at no gain no loss, even though the companies may not be in a gains group together. If the reconstruction results in the shares of a company being transferred, and that company leaves a gains group such that a degrouping charge would ordinarily Reed Elsevier UK Ltd FA 2014

7 arise, no additional consideration arises to the transferor (in the example above, A Ltd), i.e. there will be no degrouping charge. TCGA 1992, s.139(1b) We will look at the position of the shareholders of A Ltd below. Illustration 3 Bootle Ltd has two trades. It transfers Trade 1 to Newco. In return Newco issues shares to the existing shareholders of Bootle Ltd. Subject to meeting the requirements of TCGA 1992, Sch 5AA, Bootle will be treated as having transferred any chargeable assets to Newco for a consideration that would result in neither a gain nor a loss arising in Bootle Ltd. Newco will be treated as having acquired the assets for the same sum Reconstructions shareholder position Similar rules to the share for share exchange rules (the reorganisation provisions) that we have seen, apply to the position of the shareholders where there is a scheme of reconstruction (under Sch 5AA, as above). As we have seen above, a scheme of reconstruction involves an issue of shares by the transferee company to the existing shareholders of the old transferor company, in proportion to their existing shareholding. In the scenario above, this means an issue of shares by B Ltd to the existing shareholders of A Ltd. The shareholders now hold B Ltd shares in addition to their old A Ltd shares. If the A Ltd shares are then cancelled this is not treated as a chargeable disposal, and the B Ltd shares take on the base cost of the A Ltd shares under reconstruction rules so they stand in the shoes of the original A Ltd shareholding. If the shares are not cancelled, the base cost of the original A Ltd shares is split across the 2 holdings based on their respective market values. TCGA 1992, s.136 Reed Elsevier UK Ltd FA 2014

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9 ANSWERS Answer 1 Before After transfer Transfer Consideration transfer Assets Stock 100,000 *120,000 Debtors 645,000 (645,000) Nil Cash 40, , ,000 Liabilities Creditors (250,000) 250,000 Nil Overdraft (500,000) (500,000) Total (90,000) Net liabilities (90,000) *Use MV Losses to be transferred are: 1,200,000 less 90,000, so 1,110,000. Tutorial Note: Share capital and reserves are not liabilities. Reed Elsevier UK Ltd FA 2014

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