Continuing the example above of £1m in cash proceeds, CGT payable would therefore only be £200,000 in the year of disposal.
The effect of the exchange provisions is that the shares received by the vendors on the transaction inherit the relevant proportion of the original base cost and acquisition date of the vendors’ original shares.
This means the new shares acquired would stand in the shoes of the vendors’ existing shares and the inherent gain of £4m would be rolled over into the Newco’s shares.
Conditions
In order for the share exchange provisions to apply, there are a number of conditions that need to be met.
The most common condition we see from a shareholder transaction perspective for vendors, is that as a consequence of the exchange, the acquiring company holds more than 25 per cent of the vendor company’s share capital.
Different share rights amongst various share classes, sweet equity allocation and the level of management rollover can make this condition complicated to review.
Another area of complexity in relation to the share exchange provisions is the classification of the buyer.
For example, these provisions only apply where the ‘company’ issues ‘shares or debentures’. If the buyer is a UK limited company, then this condition should be fairly straight forward to analyse, but if for example there is a US LLC involved in the acquisition, the treatment may require further review.
A further note on the exchange provisions is that the deferral of CGT is automatic, it is not an election which is made by the vendors, and therefore careful consideration needs to be given to the structure of the transaction.
In circumstances whereby an individual qualifies for Business Asset Disposal Relief, there is a specific election which can be made to opt out of this automatic rollover treatment.
This provides qualifying shareholders with an element of flexibility as they have the opportunity to decide whether they would rather pay CGT on the rollover element at the time of disposal as well.
There is usually a timing advantage as this decision doesn’t need to be made until the tax return submission due date, which could be up to 20 months later.
By this time, a vendor may have further information on potential timing of a secondary transaction or other investment decisions which may influence their choice of making this election or not.
Other tax risks
Examples of other tax risks which regularly crop up in transactions and would be worth discussing with clients is key relationship holders operating through personal service companies and the treatment of earn-outs.
This can open up a wide range of tax complications in the run up to a transaction and, if approached early enough in the process, can be resolved well in advance of causing any real headaches on the deal itself.
