ASSET TRANSFER TO HPC (22-26 STANNARY ST LTD WINDING UP)

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1 Audit Committee 24 June 2009 ASSET TRANSFER TO HPC (22-26 STANNARY ST LTD WINDING UP) Executive summary and recommendations Introduction This paper provides further information to the Committee about potentially winding up Stannary St Ltd at some point in the future. It also provides some information on the 410k potential tax asset on sale, as highlighted in Note 7 of the statutory financial statements. Decision The Committee is asked to note the implications of winding up Stannary Street Ltd. Background information At the February Audit Committee meeting, the Committee asked that a paper be presented to their next meeting to explain the implications of winding up Stannary St Ltd and transferring its assets into the rest of the HPC refer minutes Item 9.09/9.4. Appendix One from Baker Tilly Tax and Accounting Ltd outlines a number of tax implications associated with winding up Stannary Street Ltd. In summary, because the HPC and Stannary Street Ltd form a capital gains group for the purposes of the transfer of chargeable assets, assets transferred intra-group are transferred at a value where no capital gain or loss is realised on transfer. There would also be no stamp duty land tax exposure associated with the wind up, although a potential claw back in the three years subsequent to wind up. The main issue relates to the loss of capital allowances from the date of wind up. These allowances act to reduce corporate tax on HPC group investment income with some amounts phased in for future years. The allowances cannot be claimed after wind-up of Stannary Street Ltd because the HPC would not have a qualifying trade against which capital allowances could be claimed. The advantages of winding up the company include; - simplifying HPC statutory reporting, - eliminating the need for company directors, - eliminating company returns filing, - eliminating the cost to prepare and audit the annual financial statements for the company, currently about 5k per annum. Date Ver. Dept/Cmte Doc Type Title Status Int. Aud a ADT PPR Asset transfer Draft DD: None Public RD: None

2 The disadvantages of winding up the company are to: - loose the remaining value of capital allowance benefits relating to Stannary Street refurbishment that would offset future group investment income see financial implications. Capital gain or loss on sale The HPC purchased Stannary Street Ltd in late May 2005 from Purbrooks Ltd. The amount of subsequent refurbishment spending has more than offset the capital gain on the property up to the 31 March 2009 to the extent that there is now a potential tax asset of about 410k, being 28% of 1,465k capital loss. Refer Appendix Two for more details. If the property value increased 10% in the next 12 months and with an additional 490k capital spend in 2009/2010, the value of the potential tax asset would likely increase further. Baker Tilly advise that any capital loss on disposal of the property could only be utilized against any other current year profits in Stannary Street Ltd or carried forward against future capital gains the company might make. In the event that the company may be unlikely to hold future assets, then the capital loss may not qualify for any relief. Resource implications Nil Financial implications Net benefit from delaying the winding up of Stannary Street Ltd until after March 2011 of 14k. This includes the tax benefits from capital allowances claimable less the audit fees payable for Stannary Street Ltd. Appendices Appendix One Baker Tilly Tax Briefing Paper Appendix Two Work papers relating to the current capital loss Date of paper 12 June 2009

3 Health Professions Council Draft Tax Briefing Paper Proposed Transfer of the property 22/26 Stannary Street from 22/26 Stannary Street Limited to Health Professions Council Proposal You have asked us to consider the tax implications of the proposed transfer of the 22/26 Stannary Street property from 22/26 Stannary Street Limited to Health Professions Council ( HPC ) followed by the winding up of 22/26 Stannary Street Limited ( SSL ). Executive Summary On the basis of the analysis below the transfer of the property, 22/26 Stannary Street from SSL to HPC could be achieved without crystallising a tax liability on either party. The main tax disadvantage of the transfer would be the loss of capital allowances which are currently being claimed by SSL. Background Current Structure HPC is a corporate body established under the Health Professions Order It is a mutual association. As a mutual trader, HPC is only taxable on its income received from non-members and investment income. It is not liable to pay tax on trading profits that arise from its mutual trade and nor does it get tax relief for losses arising from and capital allowances on assets provided for its mutual trade. HPC would however be taxable in respect of any property letting business carried on by it (Property Income) if any part of its property was sub-let. A mutual trader is also liable to tax on any chargeable gains that arise. SSL is a 100% subsidiary of HPC. HPC acquired SSL in 2005 in order to acquire the property owned by SSL, which is 22/26 Stannary Street. This property adjoins HPC s premises. SSL now operates as a property investment company. The 22/26 Stannary Street property is held in fixed assets. Its principal activity is to provide office accommodation and meeting rooms to HPC for which a market value based rent is charged. SSL s profit and loss account consists of rental income from HPC, direct expenses incurred in respect of the property and administrative expenses, for instance audit and accountancy fees. In the last couple of years a significant refurbishment has taken place. Phase 2 of the project is ongoing. The costs are reflected in the accounts of SSL however they have been funded by HPC via a loan. In the 2008 corporation tax computation the refurbishment expenditure (in total some 1.4m) was analysed and capital allowances claimed in respect of plant and machinery items. The claim for first year allowances at 40% was 110,000. The surplus property trade (Property Income) loss, which

4 equated to the capital allowances claimed, was group relieved to HPC where it was offset against HPC s tax liability on its investment income. SSL is able to claim capital allowances on qualifying expenditure on the basis that it is carrying on a qualifying trade. It is important in this respect that a full market based rental is charged to HPC for its use of the premises. If a full market based rental was not charged, SSL could be open to challenge from HM Revenue and Customs that it is not carrying on a genuine trade in which case relief for capital allowances would be denied. We have reviewed the capital works cost plan for phase 2 of the refurbishment project and the attached summary shows the capital allowances going forwards for the next five years. Due to a change in the capital allowance rules, from 1 April 2008 items designated to be integral fixtures only qualify for a reduced 10% writing down allowance and are ineligible for the first year allowance of 40%. This means that allowances on integral fixtures are given at a slower rate over a longer period. As can be seen from the spreadsheet, the qualifying expenditure for phase 2 is mainly comprised of integral fixtures qualifying for the reduced 10% writing down allowance and consequently the level of capital allowances for 2009 will be lower than those claimed in On the basis that the rental income in each period is fully offset by the direct and administrative expenses incurred by SSL, the tax loss generated by the capital allowances claimed by SSL should be available to be surrendered to HPC for offset against its tax liability on its investment income. The Property Capital Gains Position - on acquisition At the time of the acquisition of SSL the property stood at a gain of circa 650,000 based on a market value of 930,000 less the original cost in 1987 of 149,000 and indexation allowance. The BDO due diligence report prepared in respect of the acquisition refers to an inherent gain of 195,000. However this would appear to be a misnomer as it is likely that this is a reference to the tax on the inherent gain ( 195,000 being 650,000 at 30%) rather than the inherent gain itself. Regardless of whether the report was referring to the capital gain or the tax thereon the report assessed the position on acquisition and the capital gains calculation needs updating for the capital spend on the property and its current market value. Current Property Valuation and Capital Gains Position Following the acquisition, HPC has funded the development of the 22/26 Stannary Street building from run down printing press works to council chambers and offices. This refurbishment work is ongoing and currently in phase 2. Phase 1 costs incurred in 2007 and 2008 total 1.4m, with further costs of 500,000 incurred in 2009 along with phase 2 professional fees of 116,000. The property has been valued at 31 March 2009 at 785,000 (land 235,000 and buildings 550,000).

5 On the basis that most of the refurbishment spend forms base cost for the property, the property currently stands at a significant capital loss of around 1.2 million. There are further phase 2 costs to be incurred in 2009/10. The total phase 2 costs are 490,000. These costs would further increase the tax cost of the property and would need to be compared against the property valuation following the phase 2 works. The Company Implications of Previous Demerger An issue was raised at the time of the acquisition with regard to the chargeable payment rules as SSL (formerly called Purbrook & Eyres Limited) was previously involved in a statutory demerger. We wrote to HMRC in December 2005 for tax clearance under Section 215 (3) ICTA 1988 that any future payments that might be made would not be treated as chargeable payments and this clearance was received. This is unlikely to be an issue in respect of the current proposal. Transfer of Property to HPC Capital Gains Tax HPC is a body corporate and holds 100% of the share capital of SSL, therefore HPC and SSL form a capital gains group for the purposes of the transfer of chargeable assets. Under section 171 of Taxation of Chargeable Gains Act 1992 ( TCGA 1992 ) assets transferred between companies in the same capital gains group are transferred at no gain no loss. The new owner of the asset inherits the base cost of the former owner plus indexation allowance so that no capital gain or loss is realised on the transfer of the asset within the group. In effect any capital gain or loss inherent in the asset is deferred until that asset is disposed of outside of the capital gains group. One of the conditions for section 171 to apply is that the asset must stay within the charge to tax. HPC is a mutual trader, however, mutual traders are liable to tax on any chargeable gains that arise. On the basis that the property remains a chargeable asset in the hands of HPC, the property would transfer to HPC at no gain/no loss under section 171 TCGA HPC would inherit SSL s base cost for the property plus indexation allowance to the date of the transfer. There would be no capital gain or capital loss crystallised on the property transfer. Please see further comment below with regard to the subsequent winding up of SSL. Stamp Duty Land Tax HPC and SSL also form a group for Stamp Duty Land tax purposes, so that on the transfer of the property the group relief provisions would apply and there would be no SDLT payable. A SDLT return would need to be submitted in respect of the transfer and group relief claimed. HPC should take legal advice in respect of this. There are rules under the Capital Gains and SDLT provisions which can claw back the group relief allowed if there are certain changes to the group that occur after the

6 transfer. Please see further comment below regarding the subsequent winding up of SSL. Tax Consequences for SSL Capital Allowances Following the transfer of the property SSL would cease to trade. As the assets are transferred to a connected party the disposal takes place for capital allowances purposes at market value. Disposal proceeds are brought into the pool and a balancing charge or balancing allowance will arise. An assessment on an apportionment basis needs to be made of the market value of the expenditure qualifying for capital allowances. As a mutual trader HPC would not be able to claim capital allowances on the property as it does not have a qualifying trade against which capital allowances could be claimed. Consequently the capital allowances on the remaining tax pools would be lost. This would not be tax efficient as currently the losses generated in SSL through claiming capital allowances are able to be surrendered to HPC to reduce its taxable investment income. Although it should be noted that the tax losses generated by SSL s claims for capital allowances will naturally reduce over time given that capital allowances are calculated on a reducing balance basis. Winding up SSL Tax Consequences Following the property transfer HPC wishes to wind up SSL. Capital Gains Tax The winding up of SSL would mean that the HPC capital gains group ceases to exist. There is therefore a danger that the group relief could be clawed back. Section 179 TCGA 1992 introduces an exit charge if within six years of the original transfer the company holding the asset leaves the capital gains group. Section 179 may be invoked as HPC could be viewed as leaving the group as the group no longer exists. However, section 179 does not apply in cases where a parent company ceases to be a member of a group on the occasion of its subsidiary ceasing to exist on dissolution. In any event at the date of the transfer the property is standing at a capital loss so there would be no gain to bring into charge. Stamp Duty Land Tax There are similar anti-avoidance provisions in the SDLT legislation that provide for a claw back of group relief if the purchaser leaves the group within three years of the transfer. However group relief should not be withdrawn where the purchaser ceases to be a member of the same group as the vendor because of the winding up of the vendor.

7 If a cautious view was taken HPC could consider leaving SSL in situ as a dormant company so that the HPC and SSL group remains in place and does not come to an end. However this would not appear to be necessary. Winding Up SSL The accounts of SSL currently show a significant net liability position and the company owes a significant debt to HPC who has funded the property redevelopment. This net liability position would need to be addressed before the company could be wound up or struck off. A formal waiver of the debt or capitalisation of the debt may be options. HPC will need to take further legal and accounting advice on this. A formal waiver/release of the debt or capitalisation of the debt should be able to be achieved without any adverse tax consequences on wither party.

8 22/26 Stannary Street Limited (formerly Purbrook & Eyres Limited) 7 months ended 31 March 2005 E1 property Costs Net gain Disposal proceeds: 31/03/ ,000 31/03/1987 Original cost - index: ,125 (149,125) 780,875 Indexation allowance (133,318) Chargeable gain 647,557 A3 Page 1

9 22/26 Stannary Street Limited (Formerly Purbrooks & Eyres) Year ended 31 March 2009 C Stannary Street Costs Net loss Disposal proceeds: 31/03/ ,000 31/03/1987 Original cost 149,125 31/03/2008 Capital spend ,219,307 31/03/2007 Capital spend ,656 31/03/2009 Capital spend ,543 2,249,631 Acquisition costs allowed (2,249,631) Capital loss (1,464,631) C1 Page 1