Share capital changes: what it means for your personal tax

TaxTalk - March 2023

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When a company reorganises its shares, what is the impact for individual shareholders?

Commercial reorganisations, mergers and acquisitions are very common. Although there will be commercial decisions driving the restructuring, shareholders must consider the impact on their personal wider tax position.

The restructuring will often include a share for share exchange. So how does this affect shareholders?

What is a share for share exchange?

This is the process where a company exchanges or issues shares in consideration of the exchange or issues of shares in another company. In other words, the shareholders swap their shares in one company for shares in another or different shares in the same company

There are special rules governing share for share exchanges. The main benefit of these rules is that, as a result of the exchange, the shareholders are not considered to have disposed of their original shareholding. This means the exchange doesn’t trigger a dry tax charge on the shareholder. Instead, the new shares are deemed to ‘stand in the shoes’ of the original shareholding.

A company planning to carry out a share for share exchange transaction can apply to HMRC for clearance to confirm that the rules would apply.

Whilst the exchange itself may not trigger a disposal, it’s important to consider if the reorganisation could have a wider effect on the individual shareholders’ tax position.

Non-domiciled shareholders

In the Autumn statement, the Government announced new anti-avoidance measures. These aimed to stop non-domiciled individuals from avoiding UK tax on chargeable gains made on the disposal of UK business, by taking advantage of the share for share rules.

These new rules apply to share for share exchanges or schemes of reconstruction after 17 November 2022. The measure only affects shareholders holding 5% or more of a close company.

The rules mean that shares received in a non-UK company in exchange for shares in a UK company, will continue to be treated as UK shares for Capital Gains Tax (CGT). Dividends will also remain in the scope of UK tax.

Although these rules are fairly esoteric, it’s important that affected shareholders are aware of them. Whilst they will no longer own UK shares, the effect of these rules is to treat foreign shares as being UK. As such, they are outside the scope of the remittance basis.

These measures apply to Income Tax and CGT, so the exchange would still be effective for Inheritance Tax (IHT). But, as the UK shares would most likely have qualified for 100% business property relief, this is unlikely to be relevant.

Impact on Business Asset Disposal Relief

Business Asset Disposal Relief (BADR) reduces the rate charged on the first £1m of qualifying disposals from 20% to 10%. For BADR to apply, the shareholder must have owned more than 5% of the trading company, and be an officer or employer, for the 24 months leading up to disposal.

The share for share exchange rules will stop a taxable gain arising on the share swap. But the exchange could impact the availability of BADR in the future.

For example, BADR might not be available on the new shares if, as a result of the exchange, the shareholder will own less than 5% of the new company or there will be a disposal within two years.

Because of this, it is possible to disapply the share for shares rules. The decision either way has to be made by 31 January following the end of the tax year of disposal.

Opting to disapply the share for share rules means:

  • a gain will be calculated as if the value of the new shares received was cash. The gain will then qualify for BADR.
  • the new shares will have a base cost equal to the market value at the date of takeover.

The effect is that the exchange is immediately taxable, but reduces the gain on a future disposal. So it’s important to consider whether the election is appropriate.

Impact on SEIS and EIS

SEIS and EIS are advantages share schemes that provide Income Tax repayments equal to 50% or 30% respectively of the amount invested, and valuable exemptions from CGT.

Usually, if these shares are disposed of within three years, these reliefs are lost. As a share for share exchange counts as a disposal, it could result in the loss of these valuable reliefs.

There are rules which can allow the new holding to continue to qualify for relief. But strict requirements apply which are more onerous than the general share for share exchange rules.

In a nutshell:

  • the new company must have no shareholders other than subscribers before the share exchange.
  • the consideration for the old shares must consist wholly of the issue of the new shares in the new company.
  • the consideration for the new shares of each description must consist wholly of old shares of the corresponding description.
  • HMRC must have confirmed in advance that CGT relief for the share exchange will not be disapplied on tax avoidance grounds.

In general, the continuation will apply where the shares are acquired by a new company and are the sole consideration. HMRC clearance should be obtained if EIS is applicable to some of the shares.

Impact on IHT

Shares in unquoted trading companies can qualify for relief from IHT at up to 100%. This is a very valuable relief.

To be eligible, the shares must be owned for the two years before death. But there are certain exceptions to the two-year ownership requirement for replacement business property. This will be apply if the property replaced other property that qualified for business property relief, and the combined period of ownership is at least two of the last five years.

What’s more, where there’s been a share for share exchange and the new shares would be identified with previously held qualifying shares, the owner may treat the period of ownership of the new shares as including that of the original shares.

When a company is undergoing a reorganisation, it’s important that the individual shareholders take personal advice about the effect on their wider tax position. If you would like help with any of the issues raised in this article, please contact Stephen Kenny.