Takeovers and Rights Issues
Takeovers
Let's assume you buy 1,000 shares in Gordon plc for £1 each. The company does well and attracts a takeover bid from Monster plc. Monster plc could either make a cash offer for your shares or offer you shares in Monster plc in exchange.
A cash payment will result in capital gains tax having to be paid. If Monster offers you £10 per share, you will have a gain of £9,000 (before deducting any reliefs).
If Monster offers you shares in its own company in exchange, there are provisions that can apply so that there is deemed to be no taxable gain and the new shares are deemed to have been acquired on the same date as the Gordon plc shares. The new shares are treated as 'standing in the shoes' of the old shares.
There are certain Revenue and Customs conditions that must be met but which are not worth examining in any detail here.
Rights Issues
If a shareholder decides to take up a rights issue no taxable gain arises. In many cases, however, shareholders accept cash payments instead. A sale of rights is classed as a part disposal for capital gains tax purposes. The tax calculation is based on the increase in value of a proportion of the original shareholding.
Under normal circumstances, the proceeds will be the amount received for the sale of the rights.
However, the sale of rights is not treated as a disposal if the proceeds are 'small'. 'Small' is not defined in the legislation. However, HMRC states that it will treat proceeds as small if they are equal to or less than 5 per cent of the value of the underlying shares (at the date of the rights issue), or £3,000, whichever is the greatest of these figures. When these conditions are met, it is referred to as a small part disposal and in most cases the proceeds are subtracted from the base cost which essentially transfers any gain arising from the sale of the rights to the year in which the shares creating the rights are sold.
The small part disposal rules can therefore defer capital gains tax until a future disposal of the shares, giving a valuable cash flow benefit, as you will already have received cash when you sold your rights.
Calculating the Cost of the Rights
As with any asset, in order to calculate any gain arising, we need to be able to identify the cost of the asset disposed of. The cost of the rights is taken to be a proportion of the base cost of the shares creating the rights. When all the rights are sold, this proportion is given by the following formula:
Base cost × sale proceeds /(current value of original shares + sale proceeds)
When only some of the rights are disposed of, and some are taken up, the denominator (the part in brackets) in the above formula changes to:
(Current value of original shares + value of rights taken up + sale proceeds)
For the majority of small investors, the sale of rights will not result in tax having to be paid due to the effects of the small part disposal rules and the application of the annual CGT exemption.
If you don't think you will have other chargeable gains in the tax year you sell your rights, the small part disposal rules can be 'disapplied' so as to ensure that a chargeable gain arises which will be covered by the annual exemption.
About the Author
The Author of this article is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).
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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