IN105 - UK Holding Companies - Capital Gains Tax Exemption Explained

This article explains the conditions needing to be met for UK holding companies to enjoy the Substantial Shareholdings Exemption Regime for corporation tax on capital gains. These conditions may not be as restrictive as they first appear.

Reasons why the United Kingdom is such a Leading Corporate Domicile for Holding Companies

• The UK has the largest network of Double Taxation Treaties. In most situations where a UK company owns more than 10% of the share capital of an overseas subsidiary, the rate of withholding tax is reduced to 5%. In addition, as the UK is a member of the EU, UK holding companies have access to the EU Parent Subsidiary Directive, which can reduce withholding tax on dividends to 0%.
• The UK does not offer a total participation exemption regime. The exact terms of this participation exemption regime vary, depending on whether the investing company is small or not (see Dixcart article 209).
• The UK does not levy withholding tax on dividends paid from UK companies.
• Participation exemption does exist for capital gains realised from the disposal of substantial shareholdings.

Substantial Shareholdings Exemption Regime for Corporation Tax on Capital Gains

Conditions for exemption

• The shareholding in the investee company must be substantial. This means that the holding must be not less than 10% of the investee company’s ordinary share capital.
• The UK company must be the beneficial owner of the substantial shareholding.
• The substantial shareholding must have been held for a continuous period of 12 months in the two years prior to disposal. This is known as the qualifying period.
• The UK company and the investee company must be able to demonstrate a trading status, either by showing that they are trading companies or by showing that they are members of a group or sub-group which carries out trading activities. This trading status must be maintained throughout the qualifying period and immediately after the time of disposal.

An example to explain how the provisions apply



In this example the UK company holds 51% of the shares in a Danish trading company and 10% of the shares in a French trading company. The French trading company has two other shareholders in addition to the UK trading company (Shareholder 1), who hold 50% of the shares and 15% respectively, with the remaining shareholders (Others) holding the balance of the shares in the French company.

Sale of shares in the Danish company

We will assume that the shareholdings in the Danish company and the French company were acquired on the 6th June 2005. On the 20th March 2009 the UK company sells its holding in the Danish company.

Prior to disposal, the conditions for meeting the substantial shareholding election have been met:

• The UK company held a substantial shareholding in both the Danish company and the French company, i.e. 10% or more.
• At the time of the disposal, the UK company had held 51% of the ordinary share capital of the Danish company for a continuous period of 12 months in the two years prior to disposal. The qualifying period had therefore been met.
• Whilst the UK company did not itself trade, it was part of a trading group as the Danish company and the French company were trading companies.

The concept of a joint venture company

It should be noted that it is also necessary for the UK company to be a trading company or a member of a trading group immediately after the disposal of the Danish company. Initially it would appear that this is not the case.

The substantial shareholdings exemption however adopts the concept of a joint venture company. A joint venture company is one where 75% or more of the ordinary share capital is owned by five or fewer persons. In the example 75% of the shares of the French company were owned by three shareholders and it is therefore clear that the UK company held shares in a joint venture company. The holding company is therefore assumed to be conducting an appropriate proportion of the activities of the joint venture company, which are trading activities, and therefore the holding company satisfies the trading requirement immediately after the disposal of its shares in the Danish company.

Sale of shares in the French company

Let us now assume that the UK holding company then wishes to sell its shares in the French company. Once again, it meets the status requirements immediately prior to the sale of the French company, in that it will have held the shares in the French company for a continuous period of 12 months in the two years prior to disposal and it was a member of the trading group up to the time of the disposal.

Immediately after the sale of the shares in the French company, the UK company is no longer a member of a trading group.

Trading activities, however, are defined to include activities undertaken with a view to acquiring a significant interest in the share capital of a trading company or of a holding company of a trading group or sub-group. Significant interest would be 51% control, or not less than 10% of a joint venture company.

The UK company could therefore explore options in terms of acquiring an interest in a new trading subsidiary and would therefore still qualify as a trading company immediately after the disposal.

The UK company wishes to realise the gains on the sale of the French company

In our example we will assume that the UK company’s shareholder wishes to enjoy the benefit of the money realised by the gains on the sale of the French company and therefore the UK company will not be looking to invest in another trading company.

This would mean that the UK company would not be able to maintain the status requirement of being a trading company or a member of a trading group or sub-group immediately after the disposal. However, the gain of the UK company will still be exempt from UK corporation tax, provided that:

• The UK company held a substantial shareholding in the French company throughout a twelve month period in the two years prior to disposal, AND
• The UK company’s failure to be a trading company or member of a trading group after its disposal was due to the fact that it was being wound up or dissolved, or was to be wound up or dissolved as soon as was reasonably practical.

In these circumstances it is important that, after disposal of the French company, the UK company should immediately take the necessary steps to bring the UK company’s existence to an end.

Summary

At first glance the rules regarding the Substantial Shareholdings Exemption Regime seem to be limiting. In practice, where a substantial interest in a trading company is being disposed of, it is likely that a full exemption to corporation tax on the capital gain will apply.

Additional Information

If you have any questions about UK Holding Companies, please speak to Laurence Binge in our Esher office or contact us.