The recent case of M Group Holdings Ltd v HMRC highlights a quirk in the corporation tax rules for companies which ended up costing the taxpayer over £10 million. Frustratingly for the company involved, this additional tax could have been avoided if the company had simply set up a dormant subsidiary.
M Group was a well-established, successful company, trading under the name ‘Medinet’. The business provided services to NHS hospitals and clinics. In 2015 the company began to receive interest from potential buyers. However, the company had unresolved tax enquiries that were unattractive to purchasers. Consequently, in June 2015, the company incorporated a subsidiary (Newco) into which the trade and assets of Medinet were transferred (or ‘hived down’) a few months later.
In May 2016 Newco was sold for approximately £55 million, realising a gain of circa £53 million.
The company filed its tax return claiming that the gain was non-taxable by virtue of the Substantial Shareholdings Exemption (SSE).
SSE provides a relief for holding companies which sell a trading subsidiary in which they hold a ‘substantial shareholding’. This is broadly defined as holding more than 10% of the shares. To qualify, the 10% shareholding needs to have been owned for a full 12 months.
Prima facie this condition was not met in M Group’s case (the disposal occurring only 11 months after Newco was set up). However, the taxpayer had taken advice from their accountant and a tax barrister who highlighted a special rule (paragraph 15A of Schedule 7AC TCGA 1992). This stated that if Newco had received an asset from another group company (i.e. M Group) that had previously been used by that company for the purposes of a trade and continued to be used for trading purposes by Newco, then Newco would be treated as having been owned for the combined period for the purposes of satisfying the 12 month rule.
HMRC argued that although it was the case that M Group had previously used the assets in its trade (and for longer than 12 months), it was only possible to include the period when Newco existed. Before then, M Group had been a standalone company and therefore there was no group.
A closer look
The case hinged upon two specific clauses in the legislation. The first related to the condition laid down in sub paragraph 2(d):
(d) that the asset was previously used by a member of the group (other than the company invested in) for the purposes of a trade carried on by that member at a time when it was such a member.
Sub-section 3 then went on to say that, when considering how long an extension to allow for the ownership of Newco:
(3) The investing company is to be treated as having held the substantial shareholding at any time during the final 12 month period when the asset was used as mentioned in sub-paragraph (2)(d) (if it did not hold a substantial shareholding at that time).
M Group argued that sub-paragraph 3 only required the assets to have been used by a member of the group during the 12 month period, not that there needed to be a group in existence for the whole 12 months.
The Tribunal agreed with HMRC that the legislation, on a plain reading, referred to assets needing to be used by a member of the group at a time when it was such a member. Accordingly, the taxpayer could not look back any further than June 2015. Had they waited another month, £10 million would have been saved.
Alternatively, if M Group had owned a separate dormant subsidiary throughout the required ownership period, SSE would have been available because a group would have existed for the whole of the required period. The Tribunal accepted that this was an odd quirk of the rules, but concluded that there was no justification to depart from the ordinary purposive meaning of the legislation.
Forbes Dawson view
It is worth noting that HMRC’s guidance has for some time explained their view on this bit of legislation (which we agree with). For this reason it seems crazy that the company went ahead with the sale when waiting a month would have saved such a large amount of tax.
As a general rule, it is worth companies setting up dormant subsidiaries if there is a chance of a hive-down and sale within the next year.
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