gains without any obligation by fiscal law to distribute the same. Again however, there is the latent gain on the shares with a liability to income tax and possibly surtax if the gains are in fact distributed, other than on liquidation. The expanding business which needs to retain profits and capital gains is however, in general, not as badly off, as a close company, as might first appear.

Franked Investment Income

10. The distinction between "franked" and other investment income is material if a company has surplus cash which it wishes to invest. In general, the holding of such funds may create shortfall problems, because, if cash is readily available, there is often difficulty in justifying the retention of profits under the "requirements of the business" provision. However it often happens that a company needs to retain or build up funds for a long-term project and there is the problem of investment in the meantime. Where possible, the company should consider investment of these monies in securities which produce "franked investment income" such as equity or preference shares, rather than in debentures, loan stock or similar interest-bearing securities, since the company will neither have to pay corporation tax on the income received nor Schedule F (distribution) tax and gets the benefit of the set-off facilities available. To a large extent, therefore, the company will be better advised to invest at a lower yield in franked investment income securities than in other securities giving a higher yield, because the net value to the company is greater.

Loan and Share Capital

11. On the other side of the coin is the financing of the company itself, and, in a close company, the question of share and loan capital structure is of vital importance in view of the different tax treatment of interest and dividends. All dividends and some loan interest and, in a close company, interest paid to certain persons on all loans, constitute "distributions" and have to be paid out of profits which have already borne corporation tax. Indeed, where a shortfall assessment can be reduced or avoided so that distributions are not necessary, then dividends often are severely restricted or waived because of their high cost to the company.

12. Preference shares in particular are extremely costly to finance and, where it is not possible or appropriate for dividends to be waived, and, where a shortfall assessment does not make such dividends necessary, consideration should be given to converting these under a scheme of arrangement to (say) debenture stock. 10 Ideally the debentures should be held by persons who are neither directors who are participators or associates of participators, nor associates of such a director. Even if not so held, such a conversion, if applicable, might overcome the "extended meaning of distributions" problem, since the interest on the debenture stock would not seem to be payable in respect of "money advanced by any person",11 but the Revenue are likely to attack this contention.

'Finance Act 1965, Sched. 11, para. 1 (d).

10 Caution is required because this would be a reduction of capital and might in certain circumstances be a distribution. It is also considered that such a conversion could give rise to a counteraction of the tax advantage under Finance Act 1960, s. 28, but it is not easy to see how this Section could be applied despite its widely drawn terms. The expert is however referred to the inherent danger.

13. So far as loan capital in general is concerned however, the interest payable will often amount to a distribution in the case of a close company. If the interest is paid to a person (or company) who is not a director or associate,12 and provided it is not otherwise a "distribution", then it constitutes an allowable deduction for corporation tax purposes, even if the money is indirectly supplied by the director, participator or associate. The simplest example of this (although banking restrictions at present often make this impracticable) is a loan by a bank to the company secured by a corresponding deposit or guarantee by the participator director or associate. If at all possible, any loans required by the company which are to bear interest should be provided by qualifying "outsiders". 13

14. The question is however far more material when the company needs additional finance for the purchase of say property as a fixed asset. Here the shareholders or directors, instead of lending the money to the company, can purchase the property and rent or lease it to the company and so long as the rent represents a reasonable commercial return it is allowable as a deduction from the profits of the company.14 In addition if the property is likely to appreciate in value, the gain, when made, will be subject to a lower capital gains charge than if the property is owned by the company, where there is an inherent double tax charge (but see para. 16, post).

15. There are some marginal cases where interest paid to a participator director or associate may be allowable. These concern interest paid on unpaid remuneration or purchase monies, rather than on loans. Thus, if directors' remuneration is left undrawn and remains as such on the books of the company, it would appear not to be "money advanced" so that any interest payable thereon should be allowable. Similarly if a company purchases property from or through a participator director for example13 and the purchase price remains “unpaid”, and is not transferred to a loan account, then the purchase price would not appear to constitute "money advanced" and interest payable thereon should also be allowable. Where the company needs the money in these cases and the particular director or vendor is the only source, then this is worth doing13 but it is emphasised that these are border-line cases which turn on the interpretation of the words "money advanced"16 and are likely to be fought by the Revenue.

Capital Gains Replacement of Business Assets ("Roll-over" Relief)

16. There is one advantage to a continuing company in owning its fixed assets, notwithstanding their potential appreciation in value. Whilst a company is in general liable to pay corporation tax on any chargeable gains made on a sale of fixed assets used in the trade, the liability can be deferred in certain cases where the proceeds are re-invested in similar assets. 17 Thus, for example, if a company sells a building used and occupied in the trade and re-invests the proceeds in a new building, or even in

12 And a loan creditor is a participator so is caught if he is a director or associated with a director.

13 There is one inherent advantage in the loans being made by directors etc., however, where the company cannot otherwise cover its shortfall-see Chapter 3, para. 26.

14 See Finance Act 1965, Sched. 11, para. 9 (c).

15 The property should be transferred at its proper value however because, of the capital gains aspect since the parties are "connected persons", ibid., Sched. 7, para. 21 (and see Chapter 3, paras. 14–21).

16 Finance Act 1965, Sched. 11, para. 9 (1) (a).

plant and machinery, then the gain made on the sale is not then taxable, but remains inherently liable, to be taxed only when the new assets are disposed of and the proceeds not similarly invested. It is only then taxed, when the final result, taking into account the original purchase cost and any additional expenditure, shows a chargeable gain. Limited relief is granted where part only of the proceeds are applied in this way.'

18

17. Brief mention whould be made of what is known as "wasting assets". Under the provisions of the Finance Act 1965 certain assets with a limited life, e.g., short leases, were written down in value for capital gains purposes and if disposed of for more than their written down value then there was a liability to tax on the deemed gain. Certain tangible moveable property becomes exempt under the Finance Act 1968 to which reference should be made.

B. GROUPS OF COMPANIES

1. There are a number of provisions in the Finance Act 1965 which deal with a group of companies connected by similar or joint ownership of shares. To a large extent, these provisions do not bring any taxation advantage over the single company, combining in one entity all the activities that would be spread through a group, but they are designed to allow a qualifying group of companies to be treated as one unit for some taxation purposes, rather than as distinct and separate entities. The main provisions cover three taxation aspects:

(a) Group relief,

(b) Group income, and

(c) Transfer of assets.

There are a different set of rules to determine qualifying groups for each of these aspects.

Qualifying Groups

2. In all three cases the most familiar type of grouping, namely the holding company and the 75 per cent up to wholly owned subsidiary, constitutes a qualifying group. Subject to this, the groups are as follows:

(a) Group Relief.—The provisions for group relief apply to the group of the holding and subsidiary companies (and subsidiary entails ownership of 75 per cent or more of the shares1) and to (i) a trading company owned by a consortium of five or fewer companies owning all the ordinary share capital, where none of them owns 75 per cent or more2 or (ii) a trading company which is a 90 per cent subsidiary of a holding company owned by a consortium, and which is not (indirectly) a 75 per cent subsidiary of other than the holding company or (iii) a holding company owned by a consortium which is not a subsidiary of any company. Certain other qualifications apply for

which reference should be made to the statutory provisions."

18 Finance Act, 1965, s. 33 (2).

1 Finance Act 1967, s. 20 (1) and (6) (a) and (c); Finance Act 1938, s. 42.

2 Finance Act 1967, s. 20 (2) (a) and s. 20 (8) (b).

3 Ibid., s. 20 (8) (a).

Ibid., s. 20 (6) (b).

5 Ibid., s. 20 (2) (b).

• Ibid., s. 20 (2) (c).

(b) Group Income. For group income purposes there can either be a holding and subsidiary group relationships (entailing ownership of 50 per cent or more of the ordinary share capital) or (i) a trading company owned by a group of five or fewer companies with 75 per cent or more of the ordinary share capital, provided that none of them holds less than 5 per cent1o or (ii) a holding company (with 90 per cent trading subsidiaries) owned by such a group."1

(c) Transfer of Assets.—A group exists for transfer of assets purposes only where there is a principal and subsidiary company group status12 (entailing ownership of 75 per cent or more of the ordinary share capital13). There are no consortium provisions for this purpose.

3. The distinctions between the three groupings need to be carefully borne in mind where the normal 75 per cent or more subsidiary status does not exist and, where appropriate, adjustments should be made (particularly in relation to the "ordinary share capital" which covers more than ordinary shares) if the particular group status is required.

4. (a) Group Relief.—In general, where group relief operates, the losses of a “surrendering company" can be offset against the profits of the "claimant company". Where a group exists, this can be done in either direction but in the case of a consortium, losses can only be relieved upwards.14 Before the Finance Act 1967, similar relief was available by means of a subvention payment which had to be effected under an agreement for the subventing of losses. No prior agreement is now required, unless payment is actually to be made in respect of the amount surrendered by way of group relief.15 In the case of a consortium, the losses are surrendered in proportion to the members' shareholdings. 16 Group relief basically covers relief for trading losses, capital allowances, management expenses and charges on income.17 There are provisions for apportionment where accounting periods do not coincide and where companies join or leave a group or consortium. 18

(b) Group Income.-By joint election of the paying and receiving companies, dividends can be paid without prior deduction of Schedule F (Distribution) Tax and such dividends become "group income".19 They are part of the profits of the recipient company for shortfall purposes 20 but do not count towards the 15 per cent directors' remuneration limit.1 An election does not prevent the payment of dividends by way of "franked investment income", i.e. under deduction of income tax, however.

8 Finance Act 1965, s. 48 (3) (a).

Ibid., Sched. 12, para. 9 (1) and (2) and 10; Finance Act 1938, s. 42.

10 Finance Act 1965, s. 48 (3) (b).

11 Finance Act 1966, Sched. 5, para. 1.

12 Finance Act 1965 s. 55 (5) and Sched. 13, para. 1.

13 Ibid., Sched. 13, para. 1 (c); Finance Act 1938, s. 42.

14 See Finance Act 1967, s. 20 (1), (2): See references to "surrendering company”.

15 Ibid., s. 20 (4).

16 Ibid., Sched. 10, para. 1 (3), 2 (2), 3 (4) and 4 (3).

17 Ibid., Sched. 10, paras. 1-4.

18 Ibid., Sched. 10, paras. 6, 7 and 8.

19 Finance Act 1965, s. 48 (3) and Sched. 12, Part II.

20 Ibid., Sched. 18, para. 7 (1) (c).

1 Ibid., s. 74 (1).

In addition, similar provisions apply to payment of "charges on income" between members of a group so that income tax need not be deducted.3

These provisions of group relief are extremely useful even if a shortfall assessment is likely, as they enable payments to be moved across without a premature income tax charge and are vital to a company which can mitigate or negative its shortfall liability under the "requirements of the business" exemption, since, otherwise, income tax would have to be deducted and paid to the Revenue with no true distribution to support it.

(c) Transfer of Assets.-Non-trading assets can be transferred between members of groups without in general causing capital gains problems and, so long as the asset is retained within the group, then no matter which member finally holds the asset, it is deemed to have been acquired at its original cost price to the group plus any qualifying additional expenditure thereon. The provisions do not apply to a disposal of debts or redeemable shares on their redemption, or to anything which is deemed to be a disposal of shares for a capital distribution and special provisions apply to the transfer of stock which becomes or ceases to be trading stock after the transfer." In theory, a disposal by a company to its members of an asset at undervalue constitutes a distribution of the difference between the true and the undervalue' and, in addition, in the case of a close company, such a transfer reduces the cost price of the shares in the transferor company but in the case of a group transfer these do not apply.9 The Finance Act 1968 however contains detailed provisions to cover potential avoidance measures through the use of the group relief. These cover the "envelope" scheme, for example, in which an asset was put into a subsidiary at an undervalue and then the shares in the subsidiary were sold. They also cover the case where an asset is taken out at below cost to cause a loss on the shares in the subsidiary if then sold or liquidated. These provisions should be carefully studied.

Care must be taken where any asset is to be transferred in a group. Apart from the anti-avoidance measures in the new Act, there are circumstances where a potential double charge to tax can be created if the transfer is not effected in the correct way. If, for example, the asset is transferred at its true value, then whilst the gain from its true cost is still taxed on the disposal of the asset to an outsider, the "gain" made on the transfer within the group is still on the books of the transferor company and will reflect in the value of the shares of this company. There are provisions whereby the tax on the disposal of the asset can be charged to the transferor company1o but, even if this is applied, there will be a net gain left. Thus, for example, if a chargeable asset which cost £60 and is worth £100 is transferred to the principal company at £100

8 Finance Act 1965, s. 48 (7).

▲ Ibid., Sched. 13, para. 2 (1). $ Ibid., Sched. 13, para. 2 (2). Ibid., Sched. 13, para. 3.

"Ibid., Sched. 11, para. 1 (1) (e) and (2) and para. 9 (2).

* Ibid., Sched. 7, para. 18.

• Finance Act 1967, Sched. 11, para. 3 and Sched. 13, para. 5 respectively but in the case of the former, strictly only a transfer from subsidiary to parent or fellow subsidiary is excepted and not from parent to subsidiary but presumably the Revenue will not take the point, and such a transfer is not likely unless in order to sell a subsidiary when the new provisions in the Finance Act 1968 will apply.