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Chapter 3 Creating Share Interests Notes

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MCL- Corporate Taxation Chapter 3 Creating Share Interests Abbreviation Corp -Corporation SH- Shareholder MV -market value CV - current value Indiv - individual A. INTRODUCTION

1. Issue: determining the tax value of the reflective asset when shares are issued.

2. Where there is a change in the ownership structure of a corporation- such changes are predominantly affairs of capital, and so tax aspects associated with such changes are not relevant to the extent that a country does not tax capital gains.

3. The value of assets held by a corporation + the value of a corporation are reflected in the value of share interests held in the corporation. Shares are true derivatives in that they derive their value from value held at the corporate level. These problems for a tax system can be highlighted with a simple example.

4. Like so many reflections, the reflective asset (the shares) may be distorted and shaped to the want of persons controlling the artificial entity (Corp).

5. Share interests may be created, transferred, terminated and varied. Shares may be issued for cash or in return for assets. Shares issued for cash raise few income tax issues, but a brief considerations of those issues assists in highlighting the artificial and derivative nature of shares.

6. Shares issued for assets involve the additional issue of the prospective SH disposing of those assets (in return for the shares). This is a related party transaction because the corporation is controlled by the person to whom the shares are issued, or by persons related to that person. Such a disposal from one person to another would typically involve a realisation of any gains or losses associate with the assets and so have tax consequences.

7. Issue: even after the distribution of assets to a corporation in return for shares, the contributor is still in substance the owner of the assets. If this position is accepted, the consequence would be that the contribution of assets to corporation in return for share should not be treated as a realisation event, but rather some form of tax relief should be provided. B. SHARES FOR CASH

MCL- Corporate Taxation

1. There is no immediate income tax consequence of such an issue, although there may be transaction tax consequences to be considered (e.g stamp duty).

2. Distinction between par value and non-par value shares and involves the question as to whether shares are allocated a set capital amount. a. Par value of a share - notional or fictitious amount. An acquirer of shares pays the corporation the same amount of an issue whether or not the shares are assigned a par value. b. Non-par value shares - the price paid is the issue price and most like will be considered share capital in the hands of the corporation.

3. Par value shares: only the par value is considered share (or statutory) capital. The par value of shares represents the extent of liability of the SH in the context of a limited liability corporation. If par value is only partly paid on issue, the SH is liable for the remainder in specified circumstances, typically when the directors make a call on the unpaid capital. The issue price in excess of the par value (whether paid up or not pad up) is the premium, which is typically credited to a share premium account or capital reserve.

4. In most par value jurisdictions it is possible to pay up the par value of bonus shares by using credit in the share premium account (i.e by transferring credit between the two accounts).

5. Shares are property, and to a layman it may seem like shares are disposed of by the issuing corporation o the acquirer. If this were the case the issue of shares may result in capital gain tax consequences for the issuing corporation.

6. Worse: The corp's cost based in the share would be nil, so the whole amount received on issue would constitute a taxable gain of the issuing corporation. Such a tax liability would create a major discentive for issuing shares and so a major distortion between raising capital by way of debt or equity (share capital).

7. Issue of debt does not create tax consequences because the funds received when issuing debt are not a profit or gain. The cash received on issue is most often offset by the liability to pay interest and repay the loan funds when the term of the loan expires.

8. Share capital is received in return for the corporation agreeing to pay dividends and repay the share capital in the case of a liquidation (presuming the corporation to be solvent). If a transparent view of the corporation is adopted for tax purposes, when it is no different from the contribution of capital to a business conducted by a partnership or sole trader. The issue of share capital is not a transaction of sufficient substance so as to require recognition for tax purposes.

9. Some countries tax laws recognise the receipt of share capital as an issue and expressly deal with it, where other tax laws ignore the issue.

Country UK

Shares for Cash
 Recognizes no gain or loss when a corporation received money or other amounts in return for the issue of its shares.

MCL- Corporate Taxation



Does not directly deal with the treatment of share capital received by an issuing corporation. The issue of shares would be considered an affair of capital, and so only capital gains treatment is relevant. Generally, all gains accruing on the disposal of assets are chargeable gains. Shares are clearly an asset but there is no definition of 'disposal'. The better view is that a disposal (other than deemed disposal) involves a change in ownership or divestiture of rights in an asset.

The issue of shares is not a disposal because the corporation does not own the shares prior to their issue. The result is that a corporation does not own the shares prior to their issue. The result is that a corp does not realise a chargeable gain on the issue of shares.

Adheres to par value Ignore the receipt of share capital. Capital distributions to a corporation are expressly excluded from the gross income of the corporation.

Adoption of par value for share is optional (because apply state law).

IRC s. 118(a): In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.

IRC s. 1032(a): No gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for stock... of such corporation.

All income of a corporation is treated as business income and calculated according to the business income rules in the Income Tax Law. Under the Income Tax Law, business income is calculated based on profit, which is defined as the difference between the fiscal balance sheet at the start of the year and that at the end of the year.

Permits no par value shares

KStG s. 8(1): The provisions of the Income Tax Law and this act define what is considered income and how income is to be determined.

(2) Unlimited tax obligations pursuant to Article 1, paragraph 1, no. 1-3 are all to be treated as income from business operations.

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