BIM33480 | Stock: valuation on discontinuance of business: stock transferred to a UK trader

SS164-169 Corporation Tax Act 2009 and SS175-180 Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005)

Where stock from a discontinued trade is transferred to another trader who will deduct the cost of that stock in computing their trading profits, there are specific rules determining the value of the stock. There are different rules as follows:

• where the two parties are not connected,

• where the two parties are connected, or

• where the two parties are connected but an election for substituted value has been made.

The connected person rules are in S168 CTA 2009 and S179 ITTOIA 2005. Trading stock is defined in S163 CTA 2009 and S174 ITTOIA 2005. See BIM33495 for details of both these terms.

Unconnected traders

If the parties are not connected then the value of the stock is the value of the consideration, in cash or otherwise, given for the stock (S165 CTA 2009 and S176 ITTOIA 2005). The value to be taken for closing stock is the net amount realised on the transfer of the stock (see BIM33485). This means that a deduction is allowed for any expenses wholly and exclusively incurred for the purposes of the sale or transfer of the stock.

The same value must be used by both parties to the transaction (S169 CTA 2009 and S180 ITTOIA 2005) (see BIM33515). HMRC officers should liaise with their colleagues dealing with the other party to the transaction to ensure that a consistent view is taken. For a description of the mechanism for resolving any disagreements, see BIM33550.

Where the stock is transferred with other assets and liabilities, the value of the stock is the just and reasonable apportioned amount of the consideration given (see BIM33485). This will usually be the fair value used by the purchaser in their opening balance sheet which may well be the same as the value used by the parties in the sale agreement (S165(3) CTA 2009 and S176(3) ITTOIA 2005).

Connected traders

Where the parties are connected and the stock is not subject to separate rules (see BIM33510) then S166 CTA 2009 or S177 ITTOIA 2005 apply in that if the stock is sold or transferred at:

• an arm’s length price (see BIM33495) then that price is used,

• more than the arm's length price then the arm's length price is substituted,

• less than an arm's length price then the arm's length price is substituted; but if that arm's length price is greater than both the acquisition value (see BIM33495) and the price received (see BIM33495) then the parties may make a joint election under S167 CTA 2009 or S178 ITTOIA 2005 to substitute whichever is the greater of the price received or the acquisition value (see below).

Both parties to a transaction have to use the same value for the particular stock (S169 CTA 2009 and S180 ITTOIA 2005) (see BIM33515). HMRC officers should liaise with their colleagues dealing with the other party to the transaction to ensure that a consistent view is taken. For a description of the mechanism for resolving any disagreements, see BIM33550.

Connected traders with election

As mentioned above, where certain conditions are satisfied, connected parties involved can make a joint election for the value of the stock transferred to be taken for tax purposes as the greater of the acquisition price or the price actually received for it (S167 CTA 2009 and S178 ITTOIA 2005).

The conditions to be satisfied in order to make this election are that:

• the arm's length value is more than the acquisition value of the stock and the price actually paid for it,

• both parties to the sale or transfer have to elect for the relevant provisions to apply, and

• they make the election within two years after the end of the chargeable period in which the trade is discontinued; the time limit is calculated by reference to the vendor’s chargeable period, an accounting period for a company or a tax year of assessment for an individual.

If this facility to elect was not available, substantial unrealised profits could be taxed before a cash profit is realised when transactions were undertaken for purely commercial reasons. For example, a builder's land bank may be retained in a group for 15-20 years. Without the election, a group reorganisation with stock passing between traders at its commercial book value five years after acquiring the land would trigger a tax charge on the increase in its worth over its original cost even though there may not be any prospect of a commercial realisation for another ten years. To overcome this difficulty the parties can elect to ensure that unrealised gains are not taxed on the vendor.

The requirement for the election to be for the greater of the price received or the acquisition value (but not more than the arm's length value) ensures that any commercially realised profits on sale are recognised for tax purposes.

The stock is treated as being sold to the other party immediately before discontinuance and that sale as being in the ordinary course of trade. This forestalls any argument that the sale would be a capital transaction (for which a deduction would not be allowed for the cost of the stock and for which the acquisition value would be nil).

Examples

A) No election possible because arm's length value is not greater than the acquisition value

The acquisition value of the vendor's stock is the cost of £3m. The arm's length value of the stock when sold is £2m. But in fact the sale is for £1m.

In this situation the parties cannot elect that the arm's length value of £2m should not be used as the value on disposal. This is because the arm's length value of £2m is not greater than both the price of £1m and the acquisition value of £3m.

B) No election possible because arm's length value is not greater than agreed price

The acquisition value of the vendor's stock is the cost of £1m. The arm's length value of the stock when sold is £2m. But in fact the sale is for £10m.

In this situation the parties cannot elect that the arm's length value of £2m should not be used as the value on disposal. This is because the arm's length value of £2m is not greater than both the price of £10m and the acquisition value of £1m.

C) Election possible as arm's length value greater than actual price and acquisition value: actual price used as greater

The acquisition value of the vendor's stock is the cost of £2m. The arm's length value of the stock when sold is £10m. But in fact the sale is for £8m.

In this situation the parties may elect that the arm's length value of £10m should not be used and instead that value on disposal should be at actual price of £8m - as this is greater than the £2m acquisition value.

D) Election possible as arm's length value greater than actual price and acquisition value: acquisition value used as greater

The acquisition value of the vendor's stock is the cost of £10m. The arm's length value of the stock when sold is £12m. But in fact the sale is for £9m.

In this situation the parties may elect that the arm's length value of £12m should not be used and instead that value on disposal should be at acquisition value of £10m - as this is greater than the price received of £9m.