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Merger - corporation tax on winding up subsidiary

Merger - corporation tax on winding up subsidiary

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I'm doing something wrong but I can't work out what. Please help!

I have a client with balance sheet containing only £500k in cash, and shareholders funds of £10k share capital, £190k share premium and £300k retained earnings (so book value = fair value). They want to form a parent company and issue shareholders 1 for 1 with shares in the ParentCo in exchange for their shares in the original company. They apply merger relief so that the parent company balance sheet is DR £10k investment in subsidiary, CR £10k share capital. They then wish to close down the subsidiary. They declare a dividend of £300k, clearing out the retained earnings of the sub, and increasing the retained earnings of the parent. They then wind up the sub. This effectively leads to a gain on disposal of £190k since the ParentCo receives £200k but the investment was only recorded at £10k in the ParentCo. How does one account for this gain? Presumably it neither goes through the p&l, nor should be subject to corporation tax? Does it go straight to retained earnings, or another reserve? If it goes to retained earnings, the company has effectively turned non-distributable share premium into distributable reserves? I know I've got something wrong!

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Hallerud at Easter
By DJKL
26th Feb 2020 15:14

Why?

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Replying to DJKL:
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By whatdoyoumeanwashe
26th Feb 2020 15:26

Why do I want help? Because I don't know the answer.
Why do the transaction? I don't think it's relevant to the answer, but because the existing entity is registered in Guernsey and the shareholders want to move the business into a UK company.

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By johnt27
26th Feb 2020 15:40

Gut feeling without hitting the books is you treat the gain as just that, or if you're happier, as a distribution. Either way it's distributable in the parent

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Replying to johnt27:
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By whatdoyoumeanwashe
26th Feb 2020 16:07

Thanks. But surely it can't be subject to corporation tax? It was originally just share premium paid in by the shareholders, so to tax it would be extremely harsh?

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Replying to whatdoyoumeanwashe:
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By johnt27
26th Feb 2020 16:31

I'm not a tax expert but I wouldn't expect this to be taxable. It's either a distribution - no tax or a capital gain on wholly owned sub so SSE would apply if held for long enough...

Personally, I would have gone down the capital reduction route in the sub (don't know if it applies in Guernsey) and divi'd up the share premium at the very least.

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Psycho
By Wilson Philips
26th Feb 2020 16:20

Merger relief is an accounting, not a tax, issue. It doesn’t disturb the tax base cost of the asset.

You can put it through the P&L and treat it exactly as you would any other disposal of an investment - strip the accounts profit/loss on disposal from the computation of taxable trading profits and then calculate and bring in the taxable/allowable chargeable gain/loss as a separate item in the tax computations.

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By The Dullard
26th Feb 2020 16:32

Is there not a capital reduction procedure in Guernsey? Would have been a whole lot easier.

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Replying to The Dullard:
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By whatdoyoumeanwashe
26th Feb 2020 16:36

Probably. Will look into it. We haven't done anything yet so all options still possible.

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By Coops
26th Feb 2020 17:31

For tax purposes, the CGT base cost of ParentCo's shareholding in the original company will be the market value of shares as at the date of the share for share exchange, i.e. £500K.

You won't be able to claim a capital loss of £300K, as this has only arisen because of the pre-liquidation dividend, but equally there won't be a gain on the winding up.

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Replying to Coops:
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By whatdoyoumeanwashe
26th Feb 2020 17:58

Thanks, the base cost was the bit I was missing, tax wise! Obviously it's corporation tax rather than cgt, but I think the base cost point is the same either way.

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Replying to whatdoyoumeanwashe:
Psycho
By Wilson Philips
26th Feb 2020 19:25

Which is pretty much what I said earlier.

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