CTM81124 | Groups & consortia: groups - entitlement to profits or assets available for distribution: example 4 - option rights

CTA10/PART 5/Ch6

Background to example 4

The background to the example is that Company X is the true economic parent of Company Z. Company Z is undertaking a five year investment programme expected to give rise to trade losses. So this creates the possibility that Company Z will be able to surrender group relief to Company X.

However Company X has no taxable profits, and is unlikely to have future taxable profits. If it were not for CTA10/PART 5/Ch6, a company with ample profits could group itself artificially with Company Z and purchase the relief for a fee. Assume that there is such a company, which has ample profits, and that it is called Company Y. After five years Company Z becomes profitable and starts paying dividends. Matters are arranged so that when Company Z pays dividends, Company X, which is the true parent, receives them.

Facts of example 4

Company X holds 100 £1 ordinary shares in Company Z.

The ordinary shares carry normal equity rights to share in profits.

Company Y holds 300 ordinary shares.

Company X has an option to acquire Company Y’s shares exercisable after five years.

Company Y is a 75% shareholder in Company Z (CTA10/S1119 and CTA10/S1154). This means Company Y and Company Z are members of a group within the terms of CTA10/S151(1).

For the accounting period for which Company Y is seeking group relief, profits are small or non-existent. But when, as expected after five years, Company Z becomes profitable and starts paying dividends, Company X will exercise the option and acquire all the ordinary share capital in Company Z.

If there are no profits, CTA10/S165(2)(b) requires a figure of £100 to be taken as the profits available for distribution. Of this £100, £75 (£100 x 300 / 400) will go to Company Y.

But CTA10/S173 (CTM81090 to CTM81100) prevents Company Y being regarded as entitled to 75% of the distributable profits. Section 174 applies because there are in existence option arrangements satisfying the conditions of Section 173(2). Section 174(1) applies, and the option right is treated as exercised. This means that Company X is treated as acquiring all Company Y’s shares. So, upon a distribution of £100, Company X would be entitled to £100 and Company Y to nil. CTA10/S170(3) applies by virtue of section 174(2). So Company Y is entitled to nil, the lesser of the respective percentages under:

• section 165(2), that is £75, and

• section 174(1), that is nil.Company Z will not therefore be treated as a 75% subsidiary of Company Y.