In last month’s issue, we looked at the problems that were caused by HM Revenue and Customs’ hasty abolition of the beneficial ‘joint venture’ (JV) rules for capital gains tax (CGT) entrepreneurs’ relief (ER) purposes. Thankfully, as a result of effective representations by the various professional bodies, the Finance Bill (FB) 2016 provides some welcome relaxations to these rules.
Finance Bill 2016 relaxation
FB 2016 amends the existing ‘trading company’ and ‘trading group’ definitions (in TCGA 1992, s 165A (4) (9)), and this change is backdated to share disposals made after 17 March 2015.
TCGA 1992, Pt 3, (new) Sch 7ZA now provides that the activities carried on by a JV company can be attributed to the ‘investing company/group’. However, this will only be the case where the potential ER claimant referred to as ‘P’ – enjoys an effective 5% or more interest in both the shareholding and voting rights in the underlying JV company throughout the relevant twelve-month ‘ER period’. This will frequently be the twelve-months ending with the date of the CGT disposal.
Broadly, P’s effective shareholding/voting interests in the investing company are found by calculating P’s indirect shareholdings in the JV company (and adding any ‘direct’ shareholding held by P in the JV company).
In most cases, P is likely to have just an indirect shareholding in the JV company through the investing company. The effective shareholding is computed (under (new) TCGA 1992, Sch 7ZA, paras 5-8) using the following formula:
R x S x 100, where:
R = The fraction of investing company’s ordinary share capital rights (as appropriate)
S = Investing company’s fractional direct/indirect interest in the JV
Note – JV holdings held within a (51%) group structure are ‘traced’ through the group holdings. For these purposes, all 51% group holdings are treated as 100% for the purpose of the formula, which recognises that a group is treated as a ‘single entity’).
A similar calculation is made to test the ‘voting rights’ percentage in (new) TCGA 1992, Sch 7ZA, paras 9 to 12.
The entitlement to use the JV ‘transparency’ treatment is made for each shareholder claiming ER. If a shareholder has the requisite 5% or more shareholding/voting interest, they will be entitled to ‘transparency treatment’ for the JV when deciding whether the investee company/group satisfies the ‘trading status’ test (see example below). Of course, the shareholder would then have to satisfy all the other ER conditions.
Example – Post-Finance Bill 2016 attribution of JV interests
In the corporate structure below, Miracles Ltd does not carry on any business in its own right, apart from its JV shareholding in Musical Poets Ltd, which operates as a musical promoter and publisher. The shareholdings specified below carry commensurate voting rights.
Let’s assume that, in December 2016, Smokey sells his 65% shareholding in Miracles Ltd.
Smokey has an effective 26% (indirect) shareholding/voting interest in Musical Poets Ltd (calculated as 65% (interest in Miracles Ltd) x 40% (Miracles Ltd’s interest in Musical Poets Ltd). Therefore, Smokey would be entitled to attribute 40% of Musical Poets Ltd’s activities to Miracles Ltd for the purposes of determining whether Miracles Ltd is a trading company for ER purposes.
Consequently, 40% of the gross assets, sales, profits, expenses and employee/management time of Musical Poets Ltd business would effectively be allocated to Miracles Ltd. Based on these facts, Miracles Ltd would be a trading company for the purposes of Smokey’s ER claim.
Welcome changes to JV
The new FB 2016 relaxation to the ER treatment of JV structures is welcome. In many cases, the ‘transparent’ JV rule will help shareholders secure the necessary ‘trading’ status for the purposes of claiming their ER relief.
There are similar rules for companies holding interests in partnerships/LLPs – these will be covered in my next article.
Practical Tip:
When claiming ER, always check to see whether the investee company meets the 'trading' status criteria. If the investee company is a party to a joint venture, it is important to check whether the claimant shareholder can benefit from the new joint venture 'transparency' rules. This will be possible if they have at least a 5% effective interest in the underlying joint venture company. If their effective interest is less than 5%, the JV interest is treated as an investment, which may (depending on the relevant facts) prejudice the investee company's trading status.
This article is based on the current Finance Bill 2016, which may be subject to change before it receives Royal Assent.
