Tax exemption modifications are 'positive news' for real estate investment, says expert

The changes are "positive news" for institutional real estate investment, according to Jon Robinson, a tax expert at Pinsent Masons, the law firm behind Out-law.com.

The government has also announced the removal of the requirements for the selling company to be a trading company or member of a trading group and for the target company to be trading immediately after the sale. The announcements were made in a response to the May 2016 consultation on the reform of SSE. Draft legislation for inclusion in Finance Bill 2017 was published at the same time. The proposed changes will take effect for disposals on or after 1 April 2017.

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. Under the current rules, the selling company and the company whose shares are being sold (the target company) 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.

A problem with the current exemption is that although tax exempt institutional investors, such as pension funds and sovereign wealth funds, are exempt from UK corporation tax on their investment gains, UK resident companies owned by these tax-exempt funds are normally taxable. These companies cannot generally benefit from the SSE due to the presence of substantial non-trading activities in their groups.

In an attempt to make the UK a "more attractive location for investors to locate their holding platforms and related activities", the government proposes a 'qualifying institutional investors' SSE exemption. This would relax the existing SSE rules so that the target company will not have to be a trading company at any time, including during the shareholding period. In addition if the selling company holds less than 10% of the target company, SSE would still be available if the shareholding cost more than £50m.

The draft legislation provides a  list of qualifying institutional investors, covering entities that are exempt from UK tax due to their status, such as pension funds, charities and sovereign wealth funds, and UK funds that are transparent for chargeable gains purposes, such as life assurance businesses, investment trusts and 'widely marketed' UK investment schemes. REITs are not included in the list, although the government has said it will keep this under review.

For selling companies that are owned in part by qualifying institutional investors, SSE will be available on a scale ranging from zero where the institutional shareholding in the selling company is below 25%, up to full SSE where the shareholding is at least 80%.

Another general problem with the current rules identified in the consultation and addressed by proposed changes is that the trading requirements for the investing and investee entities mean that the exemption it is "complex and uncertain to administer".

The government has decided that, for SSE to be available, the selling company will no longer have to be a trading company or member of a trading group, during or after the shareholding period. Jon Robinson said that this change will "materially simplify the operation of SSE". In particular where holding companies dispose of their last trading subsidiary, or make a series of disposals and do not immediately apply the cash from each disposal to trading purposes, under current law SSE is generally precluded unless the selling company is able to be liquidated immediately following a disposal, Robinson said.

Another change will be that the target company will no longer need to be trading immediately after the sale. "This condition can be difficult to verify on a sale of a subsidiary to a third party, and often led sellers to seek contractual commitments from the buyer to preserve the trading status of the target," said Jon Robinson. This new relaxation will not apply where the sale is to a connected party, as the government says that in such cases it should be possible for the group to ensure that the target continues to trade.

The continuous 12 month period during which the substantial shareholding must be held will be changed so that it can be any time during the six years leading up to the disposal. Under current law this period is only two years, so this extension will assist where shareholdings are disposed of in tranches rather than all at once.

The consultation response acknowledges that some difficulties with the regime will remain, including determining whether the target company is 'trading' and the operation of the 'substantial' non-trading activities or assets test in complex cases.

"No action has been taken to address the point that where a share sale is subject to an earn-out, SSE is not available where a further gain is made on the disposal of the earn-out right, applying the principles from the Marren v Ingles case, as this is treated as a disposal of the right to the earn out rather than the shares in the target company," said Jon Robinson. 

"It is not surprising that the government has stopped short of a more simple and comprehensive participation exemption for share sales. Such a move would have been open to structuring and abuse, bearing in mind that the overall policy objective of SSE is to prevent further taxation arising in respect of a company whose trading profits have already been subject to UK tax; and would have required anti-avoidance rules that may have introduced further uncertainty," he said.

"However, the reforms are welcome – they address what many would consider to have been the major stumbling blocks on SSE and will be another positive tax development as regards the UK's attractiveness as a holding company jurisdiction," Robinson said.