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Corporate Tax Changes following Difficult Financial Markets

Two changes will be made in Finance Bill 2009 with retrospective effect to address particular problems, facing banks in particular, in the current economic turmoil. However, the changes will not be limited to banks and thus apply to other companies.

Grouping provisions

The grouping provisions require a 75% relationship, but this extends beyond merely holding 75% of the ordinary share capital of a subsidiary. Further tests must also be met to ensure that the real economic ownership of the group rests with the parent. Therefore the parent must also be entitled to at least 75% of:

  • profits available for distribution to equity holders or ;
  • assets on a winding up.

Equity holders include holders of all the “ordinary” share capital of the subsidiary and loan creditors where the loan is not a normal commercial loan. ‘Ordinary shares’ are any shares other than those with the sole right of a fixed return. Thus, preference shares with a variable dividend rate count as ordinary shares for this purpose.

This requirement has caused difficulties for banking groups where members of the group have issued ‘non-cumulative’ preference shares, which do not carry dividend rights where paying a dividend would breach the bank’s capital requirements. The possibility of the preference shareholders’ entitlement being to a dividend at a rate below the coupon rate or even no dividend means these shares are ordinary shares. Such shares can cause the group to fail to meet all of the 75% economic ownership requirements, with a number of significant adverse tax implications, such as loss of group relief.

For the purposes of these economic interest tests, from accounting periods beginning on or after 1 January 2008 all such preference shares in issue will be treated in the same way as fixed rate non-voting shares and this will protect groups raising finance this way from the risk of degrouping. An election will allow companies to have the change apply in respect of new share issues only. Draft clauses will be released in the New Year.

This relaxation of the definition of ordinary share capital is for the purposes of the economic ownership tests only. No change will be made to the basic requirement that at least 75% of the ordinary share capital of the subsidiary must be held within the group. So if a subsidiary company has issued such shares, and they constitute more that one-quarter of the nominal value of that subsidiary company’s share capital, that company and all of its subsidiaries will remain de-grouped from the date of issue of the preference shares. The proposed change to the definition of ordinary share capital has no bearing on the basic 75% test; the economic interest tests are relevant only once the basic 75% requirement is satisfied.

Companies computing taxable profits in foreign currency

Companies which operate overseas must compute the taxable profits or losses in the functional currency, being the currency of the ‘primary economic environment’ in which the company operates. Thus, a company trading in oil would account in US dollars since oil is traded in dollars, or a company which operated mainly through branches in the EU would account in Euros. Until now, any losses to be carried forward have been in sterling.

Any unused losses at the start of the first accounting period beginning on or after 1 January 2008 will instead be converted into the functional currency at the spot rate for the start of the period and carried forward in that functional currency, subject to an opt-out election. Similarly, all future losses will be carried forward in the functional currency. This removes exchange risk for both companies and HM Treasury alike. Again, draft legislation will be available in the New Year.

National contact

Rosemary Blundell

Director National Tax
+44 (0)115 943 5357

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