Taper Relief: welcome new legislation for taxpayers

United Kingdom
"Securities" for the purposes of taper relief

The Inland Revenue have announced that legislation is to be introduced to make it clear that all debentures will be regarded as securities for the purposes of taper relief. This will be very much welcomed by all taxpayers participating in mergers and acquisitions.

It is common for a seller of shares in a target company to receive a price (in whole or in part) in the form of loan notes redeemable at one or more future dates. Where this is the case, any gain on the sale of the shares is either deferred or rolled over into the loan notes thereby deferring a tax charge until redemption of the loan note. For tax purposes, the loan note may be either a qualifying corporate bond ("QCB") or a non-qualifying corporate bond ("NQCB"). If the loan note is a QCB the gain arising on the sale of the shares is computed as at the date of sale and is "frozen". On redemption of the QCB that gain is triggered and tax will become payable on the normal date for payment of tax on a gain arising in that tax year.

If the loan note is a NQCB the shares and the NQCB are treated for tax purposes as the same asset and therefore for tax purposes the base cost in the shares will become the base cost of the NQCB. On redemption of the NQCB a gain will be computed at that time by subtracting the base cost from the proceeds of redemption.

Where taper relief is available it operates to reduce the effective rate of capital gains tax payable on the disposal of an asset. The amount of taper relief is determined by the number of years that an individual holds the asset and whether the asset is a "business asset" or a "non-business asset". If the asset is a business asset the effective rate of CGT will be only 10% where it has been held for 4 years (not counting any time that it is held prior to 6 April 1998). In the case of a non-business asset the minimum effective rate of CGT is 24% which is only available once the asset has been held for 10 or more years (not counting any periods prior to 6 April 1998).

Since April 2000, all holdings of unquoted shares in qualifying trading companies are regarded as "business assets" for taper relief. It can be seen immediately therefore that from the seller's perspective it is desirable for the seller to be treated at the time disposal occurs as having disposed of a business asset (rather than a non-business asset) that he has held for at least 4 years. If at the time the seller sells his shares in the target company, he has not accrued maximum business taper relief then it will be desirable for the seller to take loan notes in the purchaser and for these loan notes to be on terms such that the seller will continue to accrue business taper relief.

The first step in achieving this is to ensure that the loan notes are NQCBs. If the loan notes are QCBs then the capital gain will be computed by reference to the seller's position as at the date of exchange and that gain will be "frozen" as outlined above. It is therefore necessary to structure the loan note as a NQCB.

In order for business taper relief to continue to run one of the necessary conditions is that the NQCBs are "shares in a company" within the meaning of the taper relief legislation which defines "shares" as including "any securities of that company". The Inland Revenue have set out their view of the meaning of "security" for taper relief purposes in an article in the Tax Bulletin (June 2001). The Inland Revenue said that a mere debenture will not be a security for taper relief purposes and that any note which is a debt on a security will be regarded as a security for taper relief purposes. In order for a loan note to be regarded as a debt on a security it must, broadly, be in the nature of an investment and be capable of being realised at a profit. For "rollover" purposes, however, the requirement is only that the note be a "debenture" for tax purposes.

The Inland Revenue have now changed their view and confirmed that legislation will be introduced to ensure that the same test will apply for taper relief as for rollover, namely that it will be sufficient for taper relief purposes if the loan note is a debenture. This treatment will apply for all sales taking place on or after 6 April 2001. It should therefore no longer be necessary to put in place elaborately structured loan notes in order to preserve business taper relief.

However, it is noteworthy that the Inland Revenue are apparently maintaining their restrictive view of the meaning of security for taper relief purposes for sales that took place prior to 6 April 2001. It remains to be seen whether the courts will be asked to give their view on its meaning for pre-6 April 2001 transactions.

If you would like further information, please contact

Mark Nichols, phone: +44 (0)20 7367 2051

e-mail: mark.nichols@cms-cmck.com

Richard Croker, phone: +44 (0)20 7367 2149

e-mail: richard.croker@cms-cmck.com

Mike Boutell, phone: +44 (0)20 7367 2218

e-mail: michael.boutell@cms-cmck.com