My clients are a brother and sister who trade as a marketing business through a limited company. Ms A has 51% of the shares while Mr B has 49%.

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Wesley Leonard
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1 of 5 06/07/2012 18:06 Published on Taxation (http://www.taxation.co.

1 1 of 5 06/07/ :06 Published on Taxation ( Home > Sibling rivalry Sibling rivalry Posted: 04 May 2011 Issue: <a href="/taxation/node/23771">vol 167, Issue 4302</a> [1] Categories: Readers' Forum [2], Forum & Feedback [3] A brother and sister were co-directors and shareholders of a trading company, but have decided to go their separate ways. A company purchase of own shares is a possible route... My clients are a brother and sister who trade as a marketing business through a limited company. Ms A has 51% of the shares while Mr B has 49%. Basically, the company is reliant on the joint efforts of the two director/shareholders who each have their own specialist activities within the business; however, they have decided to part company. Ms A is not really in a position to personally buy Mr B s shares, but there are undistributed profits within the company and she was wondering whether this might be a case for a company purchase of own shares. In such a case, presumably the company and shares will need to be valued, although Mr B will be taking his own clients with him so this will have to be taken into account. An alternative idea was that both could simply set up their own businesses and wind up the existing company. Can readers provide a summary of the tax (or other) advantages and disadvantages of each approach? Query 17,787 Market Man Reply from Thicket Market Man has suggestions to allow the two shareholders to go their own way in future. Each could simply start afresh with their own new companies. This leaves the problem of accessing the accumulated reserves (as enhanced by any disposal of goodwill to the new companies). This could be paid out as a dividend and subject to income tax. If both taxpayers are only liable to basic rate tax, there will be no further liability; otherwise higher rate tax will be due. Alternatively, the reserves could be paid out as a return to shareholders in the course of

2 2 of 5 06/07/ :06 winding up and subject to capital gains tax. ESC C16 has been useful to avoid the cost of a formal liquidation. However, HMRC are now consulting on proposals to legislate this concession and it seems that in future it will only be possible for HMRC to accept capital treatment if assets are less than 4,000. A company purchase of own shares under the special conditions set out in CTA 2010, Pt 23 Ch 3 [4] is taxed as a capital gain rather than as an income distribution. This may be possible providing both cash and distributable reserves are available. It will be advisable to obtain advance clearance for this. The problem with either suggestion is that tax will be due on extracting funds, and there will be corporation tax where the company dispossess of any chargeable asset or intangible fixed asset such as goodwill. This will be a disposal to a connected person and generally open market values will be required. This will apply, for example, to the disposal of customer lists. While I hesitate to use the phrase, there is of course a third way. This is to take advantage of the demerger provisions set out in CTA 2010, Pt 23 Ch 5 [4]. The bare facts as set out lead me to think that Mr B s trade might be demerged to a new company owned by Mr B with no tax cost. CTA 2010, s 1077(1)(a)(1) [5] allows a distribution of the assets and trade to another company in exchange for an issue of shares to Mr B (being a member of the original distributing company), to be free of income tax at shareholder level. Such a scheme of reconstruction falls within the provisions of TCGA 1992, s 136 [6] and s 139 [7] so that no chargeable gain arises to shareholders and to the company making the disposal. Advance clearance is available to satisfy HMRC that this is a genuine commercial transaction with no tax-avoidance motive. This is advisable as well as clearance under the transactions in securities rules as motives are always subjective. Finally, the rules regarding transfers of trade without a change in ownership in CTA 2010, Pt 22 Ch 1 [8] (formerly TA 1988, s 343 [9]) will apply since the shareholders are brother and sister and hence related to each other (CTA 2010, s 941 [10](7), (8)). Consequently, there is no balancing event for capital allowances and no cessation or commencement of the trade. The mechanics of the demerger will involve a partition of the company by splitting the shares into A and B shares, one class having the rights to a special dividend comprising the assets to be demerged to the new company. Company secretarial matters are best left to a solicitor or other person competent in company law. Market Man will need to assess the tax, legal and professional costs involved with each suggestion to determine which is most suitable. The clients will have their own commercial considerations to bring to the discussion. Reply from Pete Miller, The Miller Partnership

3 3 of 5 06/07/ :06 I think that the correct answer to the question is neither of the above. This case looks like a prime candidate for a demerger of some sort. Since the activities of the company appear to amount to a trade, this could be done by distribution in specie, using a statutory demerger, the legislation for which is contained in CTA 2010, Pt 23 Ch 5. Essentially, this permits part of the company s business to be distributed indirectly to one of the shareholders, via a new company that will issue shares to that shareholder, leaving the other shareholder with the original company and his or her part of the trade. The statutory demerger rules mean the distributions legislation does not apply and the arrangements should also be a scheme of reconstruction for capital gains purposes, so there would be no chargeable gains on the company or capital gains on the shareholders. Clearance in advance can be obtained from HMRC in respect of the tax treatment of these transactions. For the statutory demerger rules to apply, the distribution must be for the purpose of benefiting the trade carried on before the demerger and the divided trades carried on after the demerger. Historically, HMRC has accepted personal differences between the shareholders of a company as being sufficient to satisfy the trade benefit test as, particularly with small private companies, differences between the shareholders can distract from the all important task of carrying on the business. Furthermore, the distribution must not be part of a scheme or arrangements for the avoidance of tax. If these tests, in CTA 2010, s 1081, are satisfied, it seems likely that the similar tests for a scheme of reconstruction, at TCGA 1992, s 137(1) [11] and s 139(5) [7] will also be satisfied, so there should be no barrier to the favourable capital gains treatment, either. If for some reason the statutory demerger route cannot be used, Market Man s client should consider the possibility of a demerger of the business by some other route. The most common would be a liquidation demerger using Insolvency Act 1986, s 110 [12]. Using this method, the chargeable gains reliefs previously described should still be available and the relief from the distributions legislation is not required, as a distribution in the winding up of a company is not a distribution for tax purposes (CTA 2010, s 1030 [13]). Finally, a demerger can also be achieved by a distribution in a reduction of capital, although this would probably be more complex than necessary on the bare facts of this case. This route, whereby the consideration for the reduction of capital is the indirect distribution of part of the trade, is considerably easier to achieve than it used to be, as the changes introduced by the Companies Act 2006 mean that it is no longer necessary to get a court order for the reduction of capital. Once again, clearance in advance can be obtained from HMRC in respect of the tax treatment of both these alternative demerger routes, as they should both be schemes of reconstruction for capital gains purposes. Returning to Market Man s proposals, he first asks whether the separation of the business can be facilitated by way of a company purchase of own shares (CTA 2010, Pt 23 Ch 3, s 1033 [4] s 1048 [4]).

4 4 of 5 06/07/ :06 To achieve the business split, I assume that the idea is for one of the siblings shares to be repurchased. That sibling would then retire from the company and start up afresh using a different vehicle. If all the conditions for the capital treatment are satisfied, this might be a way to achieve the commercial intention, although there would still be a capital gains tax charge on the proceeds of the share repurchase. By contrast, the various demerger routes would not carry any tax charge. In terms of the valuation issue, HMRC often accept that the share value arrived at in negotiations between shareholders is market value, as the shareholders will generally be operating at arm s length to achieve the best possible value for the buyout. That said, in this case there is another connection between the shareholders and it would not be surprising if HMRC were to challenge the valuation, so it would be sensible for the shareholders to have at least one professional valuation carried out. Finally, Market Man suggests that each sibling could set up their own business and wind up the existing company. Any proceeds from the winding up of the existing company would prima facie be received as capital, rather than as income distributions (as noted above), and entrepreneurs relief might also be available, reducing the capital gains tax rate to 10%. However, given that each of the individuals is intending to carry on part of the business through another vehicle, such an approach might be susceptible to challenge under the transactions in securities legislation (ITA 2007, Pt 13 Ch 1 [14]), with HMRC effectively contending that the shareholders have received in capital form amounts which could (and by implication should) have been distributed as income dividends. Also, if the marketing business has any assets, the disposal of these assets in the winding up could generate chargeable gains in the company, with no relief as this is not a scheme of reconstruction. Finally, if the component parts of the trade have any goodwill, there might be an effective transfer of that goodwill from the company into the new trading vehicles. Once again, there is no relief from tax on such a transfer of goodwill, which will either be a chargeable gain of the company or taxed as income under CTA 2009, Pt 8 [15], depending on whether the trade commenced before 1 April 2002 or on or after that date. As a general point in respect of all the foregoing, Market Man s clients should also take advice on the VAT aspects of any transactions undertaken (and of any fees incurred in so doing), as well as on stamp duty in respect of the demerger transactions and on SDLT if any property is to be transferred. Share this page [16] Halsbury House, 35 Chancery Lane, London WC2A 1EL Customer Services Source URL:

5 5 of 5 06/07/ :06 Links: [1] [2] [3] [4] amp;sr=normcite%282010_4a%29%20and%20part-num%2823%29&shr=t [5] amp;sr=normcite%282010_4a%29%20and%20prov-num%281077%29&shr=t [6] amp;sr=normcite%281992_12a%29%20and%20prov-num%28136%29&shr=t [7] amp;sr=normcite%281992_12a%29%20and%20prov-num%28139%29&shr=t [8] amp;sr=normcite%282010_4a%29%20and%20part-num%2822%29&shr=t [9] amp;sr=normcite%281988_1a%29%20and%20prov-num%28343%29&shr=t [10] amp;sr=normcite%282010_4a%29%20and%20prov-num%28941%29&shr=t [11] amp;sr=normcite%281992_12a%29%20and%20prov-num%28137%29&shr=t [12] amp;sr=normcite%281986_45a%29%20and%20prov-num%28110%29&shr=t [13] amp;sr=normcite%282010_4a%29%20and%20prov-num%281030%29&shr=t [14] amp;sr=normcite%282007_3a%29%20and%20part-num%2813%29&shr=t [15] amp;sr=normcite%282009_4a%29%20and%20part-num%288%29&shr=t [16]

Is the draft legislation on capital distributions really the key to consistency, asks PETE MILLER

Is the draft legislation on capital distributions really the key to consistency, asks PETE MILLER 1 of 10 06/07/2012 18:01 Published on Taxation (http://www.taxation.co.uk/taxation) Home > Unlocking dividends Unlocking dividends Posted: 15 February 2012 Authors: PETE MILLER [1] Issue: vol