Substantial shareholding exemption - a change for the better

17 March 2017

A prevailing theme of today’s UK corporate tax policy is complexity with highly technical changes being made in a number of important areas; for example, interest deductibility, loss relief and hybrids.

So, it’s refreshing to be able to report on an important area of simplification to the UK’s corporate tax code.

We applaud the government for this change as it is clear that it has listened to concerns expressed by business and the tax profession in recent years.

What is the SSE?

The SSE was introduced for disposals after 1 April 2002, to exempt from corporation tax any gains (or losses) on shareholdings which qualified as ‘substantial’ and met certain other conditions. This brought the UK into line with many overseas jurisdictions which had had equivalent exemption regimes for many years.

Broadly, a substantial shareholding is an interest in a minimum of 10 per cent of an investee company that is held for at least a year, meaning that short term trading profits or portfolio shareholding gains are excluded from the exemption.

However, the main area of difficulty with the application of the current SSE legislation relates to the requirement that both the disposing group and the investee company must qualify as ‘trading’ both before and immediately after the transaction. 

This is one manifestation of the UK’s long-standing tax policy to encourage active trading rather than passive investment to support a dynamic economy. 

It creates difficulties because not only does this deny the SSE to passive investment groups, but can also adversely affect UK trading companies that either themselves, or as part of a wider worldwide group, contain some non-trading characteristics.

In many cases, such companies have no influence over, or even knowledge of the remaining activities of the worldwide group and yet can be denied the exemption on an all or nothing basis.

What will change?

For disposals after 1 April 2017 the SSE will be simplified.

The main conditions will remain (ie at least 10 per cent held for at least one year), but the only trading condition that will be retained where the disposal is to an unconnected person will be the requirement that the investee company must be a trading company prior to the disposal.

This is a significant simplification and should mean that many more companies will be able to plan for and realise disposals with greater certainty that the SSE is available.

There are also changes that extend the qualifying time period, during which the investing company needs to have held a substantial shareholding for at least 12 months, to six years, meaning that piecemeal disposals of substantial shareholdings can continue to qualify even after the interest drops below 10 per cent in certain circumstances.

Has anything else changed?

Yes. In addition to the changes to the core SSE provisions described above, a further exemption has been introduced for UK companies, to give a full, or proportionate, exemption from corporation tax on disposals depending on the identity of their shareholders.

This change will enable the SSE to even apply to disposals of investment companies, so is a significant departure from the existing regime.

The provisions in this area will apply where ‘qualifying institutional investors’ own more than 25 per cent of the disposing company. Broadly, qualifying institutional investors are pension funds, sovereign wealth funds, charities and other investors that would have been exempt from UK corporation tax if they had realised the gain on the underlying investee company directly.

This should remove an existing disincentive to structure investments via UK holding companies, and also open the SSE up to investment structures that historically would not have qualified.

We welcome these changes, which are both a simplification and an improvement in the UK corporation tax code. Nonetheless, it will remain important for companies to take care to ensure that the conditions of the SSE are met to optimise their corporate tax profile, and minimise the risk that any unexpected corporation tax liabilities will arise.

For more information please get in touch with Dan Robertson, or your usual RSM contact.

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