Selling your company in exchange for loan notes and the new CGT rules after April 2008

When you sell your company there are various ways that you can structure the disposal. In particular the way that you receive the disposal proceeds can vary significantly. One of the top preferences for many business owners is of course to sell their shares for cash. The downside with this is that you'll be hit with an immediate tax charge, unless you can arrange to be non UK resident, in which case you may be able to avoid capital gains tax completely.

If you're UK resident and are selling shares after 6 April 2008 you'll face the new 18% rate of CGT, albeit with some possible relief under the new 'retirement relief (of which we're still awaiting details).

If you have sold or are selling prior to April 2008 and are obtaining full business asset taper relief on the disposal this may not be a big issue as you're effective tax rate will be around 10% in any case. But for cases where shares don't qualify for full business asset taper relief, alternatives could be considered.

Whether a disposal is pre or post April 2008 one option is to receive loan notes from the acquiring company. A loan note is essentially a debt due from a company. However in tax terms matters aren't so straightforward. The taxman classes loan notes as either Qualifying Corporate Bonds ('QCB's') or Non-Qualifying Corporate Bonds ('Non QCB's).

The difference between these two different types of loan notes is very important if you're selling your company. Although both of them allow you to defer any gain arising on the shares they do it in completely different ways.

QCB's V Non QCB's

I won't go into the different definitions of QCB's and Non QCB's here as this is something your professional advisers can cover, but what you do need to know is that whereas QCB's are exempt from CGT a non QCB's isn't.

Position before April 2008

If you receive QCB's in exchange for your shares, the gain is computed but is then deferred until you redeem or sell the loan notes. You'll get taper relief on the original shares but once you exchange for the loan notes this then stops (pretty obviously as the loan notes are exempt from CGT). Sounds great! Well it is in most cases, but as always there are exceptions.

You'll find that a QCB loan note is often used if high business asset taper relief has already been obtained (and if you couldn't get a cash sale) as the taper relief already accrued will be available on the future redemption of the loan notes, irrespective of whether the new company is a trading company or not. As any future gain on the loan notes is free of tax this is a win-win situation.

By contrast if you receive non QCB's in exchange for your shares any gain that arises on the future disposal of the loan notes is charged to CGT. This therefore puts Non QCB's at a big disadvantage to QCB's. However, they can still be very useful because of the way the share for loan note exchange rules work.

When you defer the gain on your shares with Non QCB loan notes the loan notes take on the characteristics of the original shares. This means you'll be deemed to have bought the loan notes when you bought the shares and for the same price. It also means that the taper relief ownership period would continue to run from the date you bought the old shares right up to the date you sold the loan notes.

So if you've not got full taper relief on your shares, using Non QCB loan notes could be the one to opt for PROVIDED the company issuing the loan notes will also qualify for business asset status. If you do this it could then increase the eventual amount of taper relief available. The downside to this is that any uplift in value of the loan notes would be taxed, whereas if you went for QCB loan notes this would be tax free. Of course in either case you can get a deferral of the original tax due on the disposal, its just a case of the later tax implications.

Redemption of loan notes after April 2008

What is the position where a company was sold in exchange for loan notes before April 2008, but the loan notes are then sold after April 2008. Will the loan notes be subject to the old rules (as above) or will the new 18% rate of CGT apply?

This is something that we've considered in the forum.

Under the normal share for share exchange provisions TCGA92/S127 provides that the reorganisation is not treated as a disposal. For example, if you'd received shares in the acquiring company instead of loan notes there would be no doubt that there was no disposal before 2008 and the disposal would be when the new shares were eventually sold.

This should also be the position with non-QCB loan notes and therefore the redemption or disposal of the loan notes would be subject to the new 18% rate of CGT and no taper relief. This means that the original gain that was deferred would be subject to the new tax rules and not the (potentially more beneficial) taper relief regime.

However where the new 'security is QCB's the share reorganisation provisions can't apply as QCB's are exempt from CGT (otherwise it would be a simple matter to use the S127 share reorganisation provisions to hold over gains into an exempt asset and the held over gain would be effectively eliminated).

Therefore there are special rules for QCB's in this type of scenario. TCGA92/S116 applies where there is a reorganisation and you receive QCB's for shares.

Where this applies the reorganisation rules above don't apply.

To quote the legislation:

'... (a) there shall be calculated the chargeable gain or allowable loss that would have accrued if, at the time of the relevant transaction, the old asset had been disposed of for a consideration equal to its market value immediately before that transaction; and

(b) subject to subsections (12) to (14) below, the whole or a corresponding part of the chargeable gain or allowable loss mentioned in paragraph (a) above shall be deemed to accrue on a subsequent disposal of the whole or part of the new asset (in addition to any gain or loss that actually accrues on that disposal); and...'

Therefore this would indicate that the gain that would be due on the shares is deferred until a disposal of the QCB's and is treated as arising at that later date.

Clearly the draft legislation applying to the new CGT regime would need to be reviewed however based on this unless there are specific provisions to the contrary it would be difficult to argue that the gain charged on the disposal of the QCB's arose at the date of exchange

It's a complex area and you should ensure that you discuss this with your professional adviser.

Sale of shares after April 2008

If you're looking at a sale of the shares after April 2008 you can still receive loan notes in exchange for those shares as above.

QCB's would apply as above and the gain that has arisen (essentially just the proceeds less costs) would be deferred until the loan notes were redeemed. The gain would then be charged to CGT at the 18% rate (less the annual exemption)but the QCB itself would be exempt from CGT.

If you received non QCB loan notes for the shares the gain and the ownership period would continue to run. As the loan notes would inherit the cost of the original shares the total gain would be the gain on the shares and loan notes. One of the main advantages of the non QCB loan note exchange (ie to generate increased amounts of taper relief on a disposal of the loan notes) would not apply.

In most cases a QCB loan note would therefore be preferred. It would only be if the loan notes were not expected to be redeemed at a profit that a non QCB could be advantageous, as in this case the gain on the redemption would be lower than the QCB alternative.

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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