Corporate Tax Groups and Intra-group Transactions - why are they tax neutral?
This is the second in a series of articles in which we explore the tax rules applying to intra-group transactions. In the first article we looked at the basic definition of a corporate group as it applies to the capital gains tax and IP legislation. We shall now see how the legislation ensures that intra-group transactions are tax neutral.
Why are intra-group transactions tax neutral?
The idea is that a corporate group represents a single economic unit – when assets are transferred between members, ownership remains within the same family. Accordingly no tax is charged until such time that the asset leaves the group.
Note however that while the concept of a single economic unit explains why these rules operate as they do, it must be stressed that the members of the group are distinct entities. The tax legislation doesn’t actually do away with this fundamental principle of corporate law.
So what does it mean when we say that an intra-group transaction is tax neutral?
We know that no tax is payable on an intra-group transaction. But it is important to note that this doesn’t simply mean that the transfer is exempt from tax. The words of the legislation are crucial.
For capital gains:
The phrase “tax neutral” doesn’t actually appear in the legislation, but the effect is the same. When company A sells an asset to fellow group member company B:
"company A and company B are treated…as if the asset were acquired by company B for a consideration of such amount as would secure that neither a gain nor a loss would accrue to company A…”
(TCGA 1992 s 171(1).
In other words, company A is regarded as having broken even on the transaction, irrespective of the actual price paid by company B and recorded in the accounts.
Why can’t the legislation simply state that the transfer is exempt? This is clearly seen from the following example.
Assume A has an investment property with base cost of £6m, and market value of £10m. If A sells this property directly to P, a chargeable gain of £4m is incurred. Instead it sells to fellow group member B, who then sells on to P. If the first sale were simply exempt, A would pay no tax, but B would have a base cost of £10m, being the price it paid to A. When B sells to P, no tax is charged because the base cost now matches the purchase price.
But this is not the effect of the legislation. The sale is not exempt, but is deemed to take place at:
“a consideration of such amount as would secure that neither a gain nor a loss would accrue to company A”
And this applies to both sides of the equation.
- A pays no tax not because the transaction is exempt, but because is deemed to have sold the property for £6m (we shall ignore adjusting for inflation and other deductions). This is the amount that ensures that A has broken even; and
- B is deemed to have bought the property for that same £6m, not the actual price of £10m. This ensures that the inherent gain of £4m is captured if B subsequently sells to an outside party such as P.
So the transfer isn’t exempt – tax is payable, but is effectively deferred until such time that the property leaves the group.
What about IP?
First of all, note that these rules apply only to IP created or acquired by the group after 1 April 2002 (CTA 2009 s 882 - in this series IP includes intangibles such as goodwill).
This time, the legislation specifically states that intra-group transfers are “tax neutral”(CTA 2009 ss 775, 776). This means that:
- The transaction is treated as not involving either a “realisation” (sale) by company A or an acquisition by company B – in other words, no transaction is deemed to have taken place. This is clearly different to the treatment for capital assets;
- Company B is treated as:
- having held the asset at all times when it was held by company A, and
- as having done all such things in relation to the asset as were done by company A.
In other words, company B inherits company A’s position – we pretend that B owned the asset all along. To emphasise this fact, the legislation then states that in particular:
- B inherits A’s original acquisition cost;
- All the tax credits and debits that A incurred in respect of the asset, are deemed to have accrued to B.
As an example, suppose A has acquired a patent for £15m. The patent has a useful life of 15 years, so A writes down the cost at a rate of £1m per annum. In year 5, A has a tax written down value of £10m and sells to fellow group member B for a market value price of £12m.
The transfer is tax neutral, so:
- B inherits A’s original acquisition cost of £15m, and pretends that it has been writing down the cost on this basis, instead of A;
- Consequently, B also inherits A’s tax written down value of £10m and continues to write down £1m per year.
If B immediately sells to an outsider, there is a taxable gain of £2m, according to the calculation:
£12m – £10m = £2m
Purchase price – Tax written down value = Taxable gain
(We do not deduct the original acquisition cost as we do with capital gains treatment. We shall explain this in more detail in a later article).
If the transaction were simply exempt, the consequences would be strikingly different.
Instead of inheriting A’s position, B would write down the patent over its remaining useful life of 10 years, on the basis of the actual acquisition cost of £12m. This gives a higher writing down rate of £1.2m per annum – even though economic ownership of the patent is within the same group.
Furthermore, B could immediately sell the patent outside the group for the same £12m, without incurring any tax liability. B will not have had time to write down the patent, so the tax written down value is equal to B’s actual acquisition cost – which happens to be £12 – so no tax to pay at all.
And finally...a few words on tax avoidance and corporate wrappers
As stated at the start of this article, the basic proposition on governing intra-group transactions is that they should be tax neutral.
However, as we demonstrated, this means much more than the idea that there should be no tax to pay. The actual words of the legislation are key to the policy that this is a deferral rather than an exemption, with the tax being paid when the asset eventually leaves the group.
In fact, the legislation goes much further than this. The wording is crucial to the idea that assets cannot leave the group without paying the tax.
For example, it isn’t possible to sell the asset tax free by using a group member as an intermediary – the latter is required to stand in the shoes of the original seller, and therefore adopts the same tax computation when selling to an outsider.
The use of a corporate wrapper to avoid a tax liability is a constant theme running through the legislation. We shall come across this in the next article, where we discuss the special rules on degrouping charges that are designed to prevent this sort of mischief.