Capital reduction by way of reducing share capital - recent clearance

Capital reduction by way of reducing share capital

Typically, one of two methods is used to reduce a company’s share capital to create distributable reserves, either shares are cancelled or the nominal value of each share is reduced.

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A reduction in the nominal value of shares does not involve a disposal for capital gains purposes, so there is no need to rely on the reorganisation provisions.

A cancellation of shares results is an actual disposal of the shares as it involves the extinction of an asset (s24(1) TCGA 92), but the reorganisation of share capital provisions (s 126(1) TCGA 92) should apply such that no disposal is deemed to have occurred for capital gains purposes (s127 TCGA). However, this may not be the end of the analysis.

Where the reorganisation provisions apply, it is provided that if the shareholder receives or is deemed to have received any consideration (other than the new holding of shares) there is deemed to be a disposal (s128(3) TCGA). In addition, where an asset is disposed of otherwise than by a bargain made at arm’s length, the asset is deemed to have been disposed of for consideration equal to the market value of the asset (s17 TCGA). Therefore, one possible view is that, in the case of the cancellation of shares, the shareholder is deemed to receive market value consideration such that there is deemed to be a disposal (via s128(3) TCGA).

This leads to the question as to whether the shareholder is deemed to receive consideration when shares it owns are cancelled. HMRC have previously stated that they had no fixed views on whether the market value rule could apply to a share cancellation. This has resulted in uncertainty such that there is a preference to reduce share capital by reducing the nominal value of shares.

In a recent situation, a taxpayer chose to achieve a capital reduction by cancelling preference shares in a wholly owned subsidiary. HMRC have provided a clearance that the market value rule does not apply in the particular circumstances. In summary, the rationale in the clearance application was as follows:

  • The cancellation of shares in a wholly owned subsidiary should not be charac-terised as a bargain otherwise than at arm’s length; the shareholder owns 100%of the equity of the subsidiary before and after the transaction and the value of the subsidiary has not been reduced as a result of the share cancellation. As a result, there is no gratuitous intent to dispose of an asset at less than market value (CG14542) and the shareholder is not making an economic profit or loss.
  • Although it is provided that “where a person acquires an asset and the person making the disposal is connected with him” the transaction is treated as being otherwise than by way of a bargain at arm’s length, this should not apply here because there is no acquisition of the shares (s18 TCGA). Even if shares are purchased, there is deemed to be no acquisition of an asset (s195 FA 2003).

This rationale could be relevant where ordinary shares in a wholly owned subsidiary are cancelled.

This article was written by Iain Kerr - Director, KPMG in the UK and Rob Norris - Director, KPMG in the UK

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