The Substantial Shareholding Exemption

The substantial shareholding exemption (SSE) applies to businesses and exempts certain gains from UK corporation tax following the sale of stock.

Where the conditions for the SSE are met but the transaction results in a loss, that loss is not allowable for corporation tax purposes and therefore cannot be used to reduce a company’s taxable profits.

The SSE

The key conditions for the SSE to apply are I the investing company’s (the seller’s) shareholding in the company being invested in (the target), and (ii) the target’s and the target’s group’s trading status. This same SSE could apply whenever there is a disposal of shares, and it does not have to be on an outright sale, as this guide refers to a seller.’ Liquidation of a subsidiary company, for example, would almost always result in the sale of shares in that company, which the SSE could apply to.

The seller’s shareholding in target (the “shareholding condition”)

The seller must:

• hold an interest of at least 10% of the target’s ordinary share capital;
• be beneficially entitled to at least 10% of the profits available for distribution to ordinary shareholders as well as certain loan note holders; and
• on a winding up, be beneficially entitled to at least 10% of the assets of the target available for distribution to such ordinary shareholders and certain loan noteholders.

The seller must hold or have held the interests described above throughout a 12 month period beginning not more than six years before the disposal of the relevant shares in target.

For a July 2018 disposal to qualify for SSE, the 10% interest must have been held for the 12 months between July 2012 and July 2013. This means that, starting in July 2013, the seller could own less than 10% of a subsidiary and the SSE could still apply to its sale, allowing a stake in a subsidiary to be sold down gradually.

There are situations where factors other than the seller’s period of ownership may be relevant, for example the holding period of the seller may be able to be extended where:

• the shares had previously been held by another company within the seller’s group; and/or
• the target is carrying on a trade that had previously been carried on by the seller or another member of the seller’s group.

Qualifying institutional investors (QIIs) are not required to hold the 10% interest in a target.  Where at least 25% of the ordinary share capital of the seller is owned by one or more QIIs the condition relating to the seller’s shareholding is met if:

• the seller holds an interest in ordinary shares in the target and the acquisition cost of these shares was at least £20,000.00
• the seller’s beneficial interest in the company is proportionate with such shares

Conditions relating to the target (the trading condition)

From the start of the latest 12 month period that is used for the purposes of determining whether the shareholding condition applies, the target must be a “qualifying company.”

A target is a qualifying company if it is a trading company or the holding company of a trading group. A trading company is a company carrying on trading activities and activities other than trading activities are not carried on “to a substantial extent”. HMRC defines ‘substantial’ for these purposes as more than 20%, though it has stated that it will consider the facts and circumstances of each case when determining whether a company engages in non-trading activities to a significant extent.

Similarly, a trading group is one in which one or more members engage in trading activities, and the activities of all members of the group, when taken together, do not include activities other than trading activities to a significant extent.

Prior to April 1, 2017, the target company had to be a qualifying company even after its shares were sold. This position posed a practical challenge in that the seller may have been forced to rely on a third-party buyer to continue operating the target company after the sale. This condition is only applicable as of April 2017 if:

• the relevant buyer and the seller are connected; and/or
• the target is carrying on a trade that had previously been carried on by the seller or another member of the seller’s group and the seller has not held the target shares for the requisite 12 month period.

In certain circumstances, the trading activity of a joint venture company may also be assigned to a target that is a joint venture partner. This allows a target, which may otherwise be carrying on an ‘investment activity, to qualify as a trading company on the basis of the trade being carried on by the joint venture company itself.

SSE subsidiary exemption: disposal of shares where SSE conditions have previously been met

The purpose of this subsidiary exemption is to allow the SSE to be available where a target has ceased trading prior to the disposal of its shares. The exemption would apply to any form of disposal but in practice is often claimed in relation to the liquidation of a company.

The key conditions for this subsidiary exemption to apply are:

• the shareholding condition is met at the time of the disposal
• following the disposal, if the exemption did not apply, a chargeable gain or allowable loss for corporation tax purposes would accrue to the seller.
• The seller is a UK resident at the time of the disposal or the gain would attach to a UK permanent establishment
• There is a time within two years prior to the disposal when a gain on the sale of target share would not have been a chargeable gain, and a loss would not have been allowed to reduce corporation tax profits.
• There was a time within the two-period prior to disposal that the target was controlled by the seller or, broadly by persons connected with the seller.

SSE subsidiary exemption: QIIs (the QII exemption)

The QII exemption applies to disposals occurring after 1 April 2017. The broad purpose of introducing this new subsidiary exemption was to improve the attractiveness of the UK to institutional investors. As such, this subsidiary exemption is limited to disposals where at least 25% of the ordinary share capital of the seller is owned by one or more QIIs.

Trustees or managers of a registered pension scheme, certain life assurance companies, persons exempt from corporation or income tax on the basis of sovereign immunity, charities, investment trusts, authorised investment funds, and trustees of certain exempt unauthorised unit trusts are all QIIs. The key benefit of the QII exemption is that it can apply to exempt a gain where the target is not a trading company, or the holding company of a trading group.

The QII exemption exempts a chargeable gain when a QII owns 80 percent or more of the seller’s ordinary share capital immediately before the disposal. If the QII owns at least 25% but not more than 80% of the seller’s ordinary share capital immediately before the disposal, any chargeable gain will be reduced by the percentage of the seller’s ordinary share capital owned by the QII, for example, a gain accruing to a seller who is 60% owned by a QII would be 40% chargeable.

If the QII has an indirect shareholding in the seller, such as through intermediate holding companies, the application of the exemption may be more complicated.