Distributions: At what tax price?

Stuart Hatcher’s recent post raised the issue that directors have been known to take the view that intra-group transfers are just that, intra-group and so what does the price attached to the asset transfer matter, especially if the asset is being distributed to its parent company?

But as Stuart points out, it is not that simple from a corporate law perspective and, as Elizabeth Small suggests in this post, neither is it that simple from a tax perspective; different taxes have different rules but a common theme is that of deeming something that has not occurred to have occurred.

Many businesses are currently looking at their profitable (and not-so-profitable) parts and wondering which could be bundled up and sold. A precursor to any such sale may well be a preliminary intra-group reorganisation. Understanding the tax (and corporate law) aspects prior to making any decisions about a reorganisation is key.

Setting the scene

A restaurant business may, for example, have a profitable pizza chain in the suburbs and a couple of Italian restaurants in city locations. With the current view that our cities may be turning from jam donuts (all the good bit in the centre) to ring donuts (nothing in the centre except parks and old/historic buildings/monuments), our restaurateur client decides to divest himself of one of his city location restaurants.

Let’s assume that the restaurateur owns a holding company (Holdco) which in turn owns two wholly owned subsidiary companies, Pizzaco (which runs the pizza chain business) and Restaurantco (which owns both Italian restaurants). There are no arrangements in place for the companies to cease to be within the same group, both companies are UK tax resident and being small or medium-sized enterprises they are assumed to be outside the transfer pricing rules.

Commercial rationale

Holdco could of course set up a new wholly owned subsidiary to own the retained restaurant, but equally the retained restaurant could be distributed to Holdco by Restaurantco by way of a distribution in specie (i.e. a distribution of the actual asset and not a cash distribution satisfied by the transfer of an asset or assets), leaving Restaurantco as a clean company which could be sold – of course this company has a trading history and a buyer will need to undertake due diligence.

You may well ask why a buyer would not simply buy the assets it wants as a transfer of a going concern (TOGC) and the answer to that is often: SDLT from the buyer's perspective and substantial shareholding exemption (SSE) from the seller's perspective. One might also query why the group doesn’t transfer the assets that it wants to divest itself of into a fresh new company (Newco); again SDLT raises its head, because whilst the intra-group transfer to Newco might be protected from an immediate SDLT liability and also from corporation tax on chargeable gains, those tax liabilities could be re-engaged if Newco left the Holdco group within three years (in the case of SDLT) or six years (in the case of corporation tax).

Assets and liabilities

After establishing that there is a commercial reason for the distribution in specie of the retained restaurant by Restaurantco to Holdco, the next step is to consider what assets and liabilities are being transferred. Here we might have:

• A property lease with a variable turnover based rent.
• Fixed plant and machinery installed by the landlord and other fixtures installed by the tenant.
• IP, i.e. goodwill and copyright.
• Stock.
• Shareholder debt and third party debt.

The critical assumption we are making is that the buyer is not "waiting in the wings" and so there is no arrangement to degroup Restaurantco (the transferor) from Holdco.

VAT

The first things to establish are:

1. Is there a VAT group registration? If there is a VAT group registration then there will be no VATable supply because members of the same VAT group are deemed not to make supplies to one another.
2. Is there an option to tax (OTT) or a real estate election (REE) in place that means that supplies of the property are potentially VATable? This is unlikely to be the case unless the restaurant has been let out – but it is vital to check.

Assuming that there is no VAT group registration in place and that value is likely to attach to the assets (other than the lease which is likely to be outside the scope of VAT if there is neither an OTT nor a REE in place), we need to consider whether there could be a VATable supply in relation to those assets.

A distribution in specie is a transfer without any consideration being given by the recipient (in this case, Holdco) and so under normal VAT rules there would be no VATable supply. However, as the goods are ceasing to be owned by Restaurantco this transaction is likely to fall within the general principle such that for VAT purposes there is a deemed market value transfer price in respect of which Restaurantco (as the transferor) has to account for VAT. That said, in our scenario it may be possible to argue that there is a TOGC and consequently, no VAT charge.

SDLT

Here the most important question to ask is whether either or both of the shareholder and third party debt are secured on the property lease?

Typically, they would be, so in respect of the distribution in specie there may well be actual stampable consideration, i.e. the amount of the debt secured on the property. As a result, reliance will need to be placed on SDLT group relief and all the conditions for such relief will need to be worked through. However, because it is the transferor (Restaurantco) that leaves the group there shouldn’t be a de-grouping charge. Care should be taken though because a later change of control of Holdco could, in some cases, trigger such a charge.

Of course, Holdco will need to be aware of any upward rent adjustments and the possible SDLT filing and payment obligations.

Corporation tax

The corporation tax position will depend on the various assets being transferred. In our restaurateur’s case:

• The property lease will be deemed as being transferred at a value (probably cost) that gives rise to neither a gain nor a loss as there is a group relationship in place.
• IP is often a tricky area, necessitating identification of the assets that are within the intangible fixed asset regime, and those assets that are not. For any assets in the regime it will be further necessary to understand whether the IP has been written down – if so then it should be treated as being transferred at tax written down value (TWDV).
• Similarly, items eligible for capital allowances (i.e. the fixtures installed by the tenant) will be deemed to transfer at TWDV.
• Stock would usually be deemed to be transferred at market value, however it may be possible for the connected companies to elect for a tax neutral basis.

Conclusion

As will be appreciated the same asset may have different deemed values attributed to it depending on which tax you are looking at. This means that not only is scrupulous record keeping crucial but also that our restaurateur should bear in mind that an intra-group reorganisation, although often of significant benefit in the long-term, needs careful corporate and tax analysis and is not necessarily a piece of cake (or in this case, pizza).

Elizabeth Small is a Partner in the Corporate Tax team.

Disclaimer

This note reflects our opinion and views as of 20 August 2020 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.