Q. Our clients are the owners of a long established family trading company (TradeCo). They are thinking about selling TradeCo, but are concerned about the risk that a buyer could require them to place a significant percentage of the sale proceeds into an escrow arrangement for a number of years, as security for their contingent liability under the representations and warranties that would typically be given in an agreement to sell the shares in TradeCo. It has been suggested that once a buyer has been found, but well before the main terms of the sale have been agreed, TradeCo should establish a wholly owned subsidiary (NewCo); and then, third party consents permitting, transfer its entire trade and undertaking to NewCo a week or so later, so that NewCo would begin to carry on the trade. If the negotiations for the sale conclude successfully, TradeCo would sell Newco to the buyer. TradeCo would then be placed in liquidation and the sale proceeds would be distributed to the members in the course of the winding up. It is hoped that the hive down of the trade would be tax neutral and that the substantial shareholding exemption (SSE) would apply to the sale of NewCo. What are the main tax risks?
A. There is a clear commercial purpose 
to these arrangements, as the clients wish to avoid having to tie up a part of the sale proceeds in escrow. This risk would be taken off the table as a result of the buyer acquiring NewCo, rather than TradeCo. Furthermore, the clients are not looking to put themselves into a better tax position as a result of implementing these arrangements. They would have been entitled to entrepreneurs’ relief (ER) on the sale of TradeCo; and, similarly, ER should be given in respect of the distribution of the sale proceeds to the members on a winding up of TradeCo. (CTA 2010 s 1030 provides that a distribution in a winding up is not an income tax distribution.) Taking into account all of the circumstances, the conditions for the general anti-abuse rule to apply in FA 2013 Pt 5 should not be met.
The transfer of the trade from TradeCo to NewCo should fall within TCGA 1992 s 171 and it should be treated as the transfer of a going concern for VAT purposes, provided that at the time of the hive down there was no binding agreement to sell NewCo to the buyer. Accordingly, the transfer of the trade should not trigger any liability to taxation. (We understand that TradeCo owns no assets for which SDLT would be chargeable as there would be a clawback of intra-group relief from SDLT on the sale of NewCo.)
There is, however, a potential technical difficulty with these arrangements under the SSE rules. FA 2011 inserted a new para 15A in TCGA 1992 Sch 7AC to extend the relief for SSE where the conditions in Sch 15 para 2 are met. Paragraph 15A treats the minimum 12 month shareholding condition as satisfied for the period that assets are used for a trade carried on by a member of a group before being transferred to the company being sold. According to the explanatory notes to the Finance Bill 2011, the rules were changed to facilitate companies operating on a divisional basis. A company which runs a number of divisions can now transfer one of its trades to a newly formed subsidiary and then sell the subsidiary within SSE. This can occur, notwithstanding the fact that it may not have owned the shares in the subsidiary for the 12 month period, provided that the assets transferred have been used by another company in the group for a 12 month period ending on the date of sale of the subsidiary.
On the basis of the wording of the conditions in para 15A, it would seem that they ought to apply to a sale of Newco, so that the degrouping charge under s 179 (as amended by FA 2011) would be exempt from corporation tax on chargeable gains in the hands of TradeCo. Unfortunately, HMRC interprets the provisions of para 15A rather more narrowly. At para CG53080C of HMRC’s Capital Gains Manual, it is stated that para 15A cannot apply where the transferee company is a newly acquired subsidiary of what was previously a single trading company. No detailed explanation is given for this view. And it would appear to be illogical, since in the example provided in CG53080C as to the application of the new rules, company A has one wholly owned subsidiary, company B. Company A receives an offer from company X to sell a particular part of its trading activity. In order to accommodate the wishes of company X, company A sets up a new wholly owned subsidiary, company C; and company B transfers a part of its trade to company C, which is then sold to company X. According to HMRC, para 15A can apply when a company has a single trading subsidiary, but not when a single trading company sets up a new subsidiary to which its trade is transferred.
HMRC’s narrow interpretation appears to overlook the fact that, if there is an interval between the transferor forming the subsidiary and transferring the trade, there would be a period during which the transferor carried on the trade as a group member. Moreover, if the policy objective of para 15A is to accommodate companies operating on a divisional basis, it would appear that a divisionalised single trading company would not benefit from the relief in the light of HMRC’s view, whereas a holding company with a divisionalised single trading subsidiary would. There would appear to be no policy reason why para 15A should apply if part of a trade is transferred (as in the example in CG53080C), but would not apply to the transfer of an entire trade, assuming that there is an interval between the single trading company forming a subsidiary and the transfer of the trade. In both cases, the trade would be carried on by a member of a group. It seems to us that it is unlikely that HMRC would deny the benefit of the relief to a divisionalised single trading company which transfers parts of its trade to a subsidiary, owing to the express policy objective. And, in our view, there is no policy reason why HMRC’s narrow interpretation should prevail in relation to a company that carries on a single trade.
