Out-Law News 2 min. read

Reform of substantial shareholdings exemption could help investment funds, says Treasury


Reforming the substantial shareholdings exemption (SSE) from capital gains tax to bring it more closely into line with international best practice could bring particular benefits to investment funds, according to a consultation document issued by the UK Treasury.

It is consulting on various options for potential reform of SSE, including specific changes to benefit the funds sector, until 18 August 2016. The government announced that it would consult on possible changes to SSE to make it "simpler, more coherent and more internationally competitive" as part of the 2016 Budget.

The consultation sets out a range of possible options for reform, ranging from technical changes to the existing legislation to a more comprehensive corporation tax exemption for gains on substantial share disposals, which would more closely reflect the regimes in place in other countries. It sets out the potential benefits of each option to the UK economy, as well as the associated risks.

Tax expert John Christian of Pinsent Masons, the law firm behind Out-Law.com, said that the consultation appeared to signal a "genuine move" by the UK government to improve and modernise the rules.

"The government is aware that the current exemption is narrower than the participation exemption for company disposals in other competing jurisdictions, and there looks to be a genuine move to improve its effectiveness," he said. "This is particularly evident in relation to funds, where the UK is rarely a preferred jurisdiction for a holding entity - but there is also a recognition that the current regime has a number of design faults which need addressing, in relation to holdings through partnerships for example."

The challenge for the government would be "achieving these aims against the self-set parameters of avoiding tax-free transfers of passive assets, and confining the exempted gains to those deriving from taxable income", he said.

"The changes could have an impact in a number of sectors, investment funds being probably the foremost. The real estate sector was hopeful that the review may lead to a relaxation of the trading condition to allow investment businesses within its scope, though the government looks to be guarded on extending beyond trading activities due to potential abuse so compelling evidence of the benefits will be needed," he said.

The SSE provides an exemption from corporation tax on capital gains realised when a UK company disposes of shares if detailed conditions are satisfied. These conditions include that the company has to have held at least 10% of the shares continuously for at least one year. The selling company and the company whose shares are being sold must both be trading companies, and their activities cannot include activities other than trading activities to a substantial extend. These conditions must be satisfied both before and after the disposal of the shares for the exemption to apply.

The government wants to consider reform of the SSE targeted towards the funds sector, although widening the exemption for all groups that have significant investment activities is also explored by the consultation. Targeting the reform at funds would reduce avoidance as it could be restricted to funds which are widely owned, regulated and subject to minimum distribution requirements, according to the consultation.

Currently, gains on directly-held shareholdings are attributed to the partners in the fund when that fund is structured as transparent for tax purposes. This is usually the case in real estate funds, for example. However, transparency does not extend to UK-resident companies owned by the fund, which will be subject to corporation tax on gains relating to share disposals. These companies will not usually be able to claim SSE because they will have substantial amounts of investment activity, which means they do not meet the trading condition.

The government said that it "understood that sovereign wealth funds and pension funds often choose to locate their holding platforms outside of the UK in countries where share disposals are exempt from corporation tax under a comprehensive participation exemption" for this reason. It is seeking views on whether any specific action should be taken to address this and, if so, what criteria should be used to define funds targeted by the reforms.

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