When an individual sells shares in (for example) a family company, and the buyer is another company, instead of receiving all the proceeds in cash up front (and/or shares in the buying company) the vendor will sometimes receive ‘loan notes’ instead.
Many loan notes are ‘qualifying corporate bonds’ (QCBs). A QCB is broadly a normal commercial loan expressed in sterling, which has no provision to be converted into, or redeemed in, a currency other than sterling (TCGA 1992, s 117(1)).
‘Rolled over’ gain
When a company is sold at a profit, a capital gain normally arises. However, there are special capital gains tax (CGT) rules on a ‘reorganisation’ of shares, such as where the family company is taken over by another company and the proceeds received by the family company members include shares in the purchasing company.
The CGT treatment on a reorganisation will normally involve gains on the family company shares being ‘rolled over’ into the purchasing company’s shares. In other words, there is normally no disposal of the original shares for CGT purposes, but the ‘new’ shares are treated as the same asset as the ‘old’ shares (TCGA 1992, s 135).
If the family company’s shares are exchanged for loan notes in the purchasing company which are QCBs, the CGT position is different. QCB loan notes are exempt from CGT. However, the ‘rolled over’ gain from the family company shares does not disappear. The chargeable gain on the family company shares is calculated when the shares are exchanged for the loan notes, but the gain is ‘frozen’ until disposal (e.g. redemption) of the loan notes (TCGA 1992, s 116(10)).
However, suppose the purchasing company’s business takes a serious downturn, and the loan notes have fallen in value prior to redemption. What if the value of the loan notes was insufficient to cover the ‘frozen’ gain deemed to arise when the loan notes were redeemed? What could be done?
Give it away?
To prevent the individual being out of pocket by facing a potentially large tax bill when the QCB loan notes are redeemed, consideration could be given to gifting the loan notes to charity. As mentioned, QCBs are themselves exempt from CGT, but the ‘rolled over’ gain is not.
However, gifts to charities are made on a ‘no gain, no loss’ basis for CGT purposes (TCGA 1992, s 257). There is also a general CGT exemption for gains accruing to charities (s 256).
HM Revenue and Customs guidance in its Capital Gains manual (at CG53723) confirms that this relief for gifts to charities also applies to a gift of QCBs which carry a deferred gain. So if the disposal to charity comes within section 257, there is no charge on the donor by reference to the deferred gain. Furthermore, HMRC confirms (at CG66624) there is no CGT charge on the charity by reference to the deferred gain on a subsequent disposal of the QCB.
In addition to being attractive to the QCB holder, a disposal may be attractive to the charity if there is still some value in the QCBs on redemption.
The above article was first published in Tax Insider (August 2020) (www.taxinsider.co.uk).