Annex 1: Minor changes in the law Change 19: Share loss relief: resolution of conflicting provisions: sections 74 and 87 and Schedule 2 (disposals of new shares, and relief after an exchange of shares for shares in another company)
This change makes clear that the provisions of section 74 do not apply to an exchange of shares to which section 87 applies. It resolves an apparent conflict between section 304A of ICTA, rewritten by ITA as sections 576J and 576K of ICTA, and section 575(2) of ICTA, rewritten in section 74, which arises from the way in which section 575(2) of that Act achieves its purpose.
This change is the same as that made in sections 136(2) and 145(3) of ITA for the purposes of relief against income tax. See Change 24 in Annex 1 to the explanatory notes on ITA.
Section 575(2) of ICTA is an anti-avoidance provision. Its purpose is to prevent a person from obtaining share loss relief in respect of shares that are not capable of being qualifying shares in a company (“Oldco”) by swapping them for shares in another company (“Newco”) that are capable of being qualifying shares, except to the extent that the person gives additional consideration for the shares in Newco. For example, the shares in Oldco may not be capable of being qualifying shares because they were purchased from another shareholder. This provision has existed since the introduction of share loss relief in 1980.
Section 304A of ICTA was first applied for the purposes of share loss relief as part of the changes to the meaning of “qualifying trading company” made by FA 1998. It deals with the continuity of the requirements to be met by Newco following an exchange of qualifying shares in Oldco for qualifying shares in Newco without change of ownership.
Section 575(2) of ICTA applies to the issue of ordinary shares (“new shares”) by Newco in an exchange or scheme of reconstruction within section 135 or 136 of TCGA relating to shares (“old shares”) in Oldco. The new shares are in these circumstances “issued in consideration of … money’s worth”, that is the transfer or cancellation of the old shares. Accordingly, if Newco is a qualifying trading company in relation to the disposal of the new shares, the new shares disposed of are qualifying shares (see section 573(6) of ICTA rewritten in section 73(2)). This is the case whether or not the old shares are capable of being qualifying shares.
Section 575(2)(a) of ICTA operates to prevent share loss relief being obtained on the disposal of the new shares where the old shares were not themselves capable of being qualifying shares by requiring the following assumptions to be made:
	first, that section 127 of TCGA does not apply to the exchange or scheme of reconstruction, so that there is a disposal of the old shares for the purposes of corporation tax on chargeable gains; and
	second, that on that assumed disposal an allowable loss would have been incurred for those purposes.
Section 575(2)(a) of ICTA then requires that share loss relief would have been obtainable on the assumed disposal on the basis that it was a disposal by way of a bargain made at arm’s length. This is a consequence of the express reference in section 575(2)(a) of ICTA to the allowable loss being incurred “in disposing of [the old shares] as mentioned in subsection (1)(a) above”. Section 575(1) of ICTA sets out the categories of disposal in respect of which a claim for share loss relief may be made, including in paragraph (a) a disposal “by way of a bargain made at arm’s length for full consideration”. This requirement is rewritten in section 68(2)(a). See the commentary on section 68 and Change 11 in Annex 1.
Unless, on the assumptions described, share loss relief would have been obtained on the assumed disposal of the old shares, share loss relief may not be obtained on the disposal of the new shares, except to that extent that any “new consideration” has been given for the new shares (see section 575(2)(b) of ICTA rewritten in section 74(4) and (5)).
Section 304A of ICTA is one of the provisions applied by section 576(4A) of that Act with modifications for the purposes of defining a qualifying trading company by reference to the requirements of section 293 of ICTA. Section 304A of ICTA has been rewritten by ITA with the required modifications, in sections 145 and 146 of ITA for the purposes of relief against income tax and in sections 576J and 576K of ICTA for the purposes of relief against income subject to corporation tax. See the commentary on sections 145 and 146 of, and Schedule 1 to, ITA in the explanatory notes on that Act.
Section 304A of ICTA relates to an exchange of securities within section 135 of TCGA affecting old shares which are qualifying shares. The type of exchange to which section 304A of ICTA applies is one which involves no change of ultimate ownership. It typically occurs when a new holding company is placed above a previously loss making company as one of the steps in obviating difficulties arising under company law in relation to distributable profits.
The effect of section 304A of ICTA as modified and applied by section 576(4A) of that Act is that, if the exchange meets the requirements of section 304A(1) of ICTA, the new shares are capable of being qualifying shares and the requirements for Newco to be a qualifying trading company are to be applied as if Oldco and Newco were one and the same company. In particular, the unquoted status requirement in section 293(1A) of ICTA (rewritten in section 143 of ITA and section 576H of ICTA) and the gross assets requirement in section 293(6A) of ICTA (rewritten in section 142 of ITA and section 576G of ICTA) are to be met only at the time of issue of the old shares by Oldco.
But if the assumptions required by section 575(2)(a) of ICTA are to be applied to an exchange falling within section 304A(1) of that Act, the requirement that the assumed disposal arises by way of a bargain made at arm’s length is unlikely to be capable of being met. This would prevent a claim for share loss relief on the disposal of the shares in Newco and render nugatory the application of section 304A of ICTA for the purposes of share loss relief.
Change 24 in Annex 1 to the explanatory notes on ITA resolves that apparent conflict, for the purposes of relief against income tax, by providing in section 145(3)(a) of ITA that nothing in section 136(2) of that Act applies to an exchange falling within section 145(1) and cross–referring to that provision in section 136(2) of that Act.
But it was not within the scope of ITA, an income tax rewrite Act, to make the equivalent changes in sections 575(2) and 576J of ICTA for the purposes of relief under section 573 of that Act against income subject to corporation tax. It is within the scope of a corporation tax rewrite Act to make them and this change accordingly does so.
The effect of this change is to ensure that, in relation to shares in Newco issued on or after 1 April 2010, the legislation no longer contains an apparent conflict between provisions. The conflict is apparent in the sense that it arises in principle but has no effect in practice.
This change is in taxpayers’ favour in principle. But it is expected to have no practical effect as it is in line with generally accepted practice.