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Chapter 5 Part 2 Transferring Share Interest Notes

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MCL -Corporate Taxation Chapter 5 (Part 2) - Varying Share Interest Suggestion 1: Consistency between taxation of dividends and capital gains on shares

1. Major option- tax on gains on disposal of shares is to tax them in a fashion consistent with the taxation of dividends. Reason: SH has various methods to get a return from shares: 2 ways: a. payment of dividend b. sell the shares

2. Dividend and gains on the disposal of shares are similar, they are not the same. a. Dividends are typically paid from realised corporate profits; gains on the disposal of shares may be a reflection of those profits but may equally be a reflection of unrealised gains at the corporate level. b. tax of gains on the disposal of shares is a new concept which takes into account at least the cost of the shares, many other types of expenses; dividends are taxed on a gross basis. c. Distribution of divid may have substantial and direct impact on the value of shares and so on gains and losses on the disposal of shares. Whereas gains and losses on the disposal of shares do not have any direct impact on divd distributed with respect to those shares.

3. Several options for dividend relief that simply cannot be replicated with respect to gains on the disposal of shares. It seems that equivalency between the taxation of dividends and gains on the disposal of shares only makes sense where dividend relief is provided at the SH level or where a classical system is used. In particular, equivalency is possible where notional dividend relief is provided at the SH level. It is essentially impossible wherever dividend taxation depends on corporate level taxation (i.e. all of corporate-level forms of divd relief and the imputation system).

4. Theoretically: possible to integrate the relief for corporation tax between the taxation of dividends and the disposal of shares. Shareholder Level consequences

1. Issue: where there is a change of ownership of corporation arising from an indirect transfer of shares. Because the issues are not different whether the transfer of shares is direct or indirect, limitations on the carry forward of corporate tax attributes on a change of ownership are discussed here.

2. Consider the tax consequences of a transfer of shares at the SH level. Where a SH holds a number of shares in the same corporation but sells only some of them, how to identify which of the shares has been sold. Country UK

Shareholder Level consequences
 TCGA s. 4(2) ... the rate of capital gains tax... is 18%. TCGA s. 4 (4) [Upper rate taxpayers pay at the rate of 28%].There is a substantial individual annual exemption, now over £10000, which is automatically indexed for inflation.

MCL -Corporate Taxation



Chargeable gains of companies are, as a general rule, included in profits chargeable to corporation tax (TCGA ss 1(2) and 8(1)). They still index the cost base of their assets (TCGA s. 53).

Capitals losses may only be set against capital gains and are available for indefinite carry forward(S TCGA ss 2(2) and 8(1)).

IRC s. 61(a)... gross income means all income from whatever source derived, including (but not limited to) gains derived from dealings in property...

Under IRC s. 1(h), the rate of tax imposed on gains of individuals on capital assets is capped at 15% for long-term capital gains. Long-term capital gain is holding an asset for > 12 months.

Under IRC s. 1211, capital losses may only be set against capital gains plus, for non-corporate taxpayers, ordinary income up to $3,000.

Under IRC ss 871 and 882, the US only taxes capital gains of non-residents effectively connected with a US business.

EStG Art. 20(2) Investment income includes profit from the sale of shares in a corporation...

EStG Art. 49(1) Domestic income for the purposes of limited income tax liability... is income from a commercial undertaking (Sections 15 to 17), for which a permanent establishment is maintained or a permanent representative has been appointed within national territory, that is obtained under the preconditions in S17. If it is a matter of shares in an incorporated company that has its registered office or administrative office within national territory.

Dividend exclusion If dividends are excluded from income, similar exclusion or exemption may apply to gains on the disposal of shares. This approach is commonly adopted in Europe for inter-corporate shareholdings and constitutes part of the 'participation exemption'.

Country UK

Dividend Exclusion
 UK fully exempts inter-corporate dividends, and yet financing costs are fully deductible.

MCL -Corporate Taxation

S192A giving effect to Schedule 7AC TCGA 1992 (UK)-This exemption applies to shares held on capital account where the disposing corporation holds at least 10% shares in the corporation whose shares are disposed of. Part disposals out of a substantial shareholding can continue to qualify for up to 12 months after 10% threshold has ceased.

TCGA Schedule 7AC para. 1(1): A gain accruing to a company... on the disposal of shares or an interest in shares in another company... is not a chargeable gain if the requirements of this Schedule are met.

TCGA Schedule 7AC para. 7: The investing company must have held a substantial shareholding in the company invested in throughout a twelve-month period beginning not more than two years before the day on which the disposal takes place.

TCGA Schedule 7AC para. 8(1): "substantial shareholding" - shares giving at least 10% of the company's ordinary share capital, distributions and surplus on winding up. (10% threshold is measured by reference to 'ordinary share capital' and an entitlement to 10% of 'profit available for distribution' )

Holdings of a 51% group of corporations may be aggregated for purposes of determining this threshold.

TCGA Sch 7AC para 18 -UK relief is only available if the selling corporation is a 'trading company' and the corporation whose shares are disposed of is also a trading co (obscurely defined as corporation whose activities do not to any substantial extent include activities other than trading activities). Not clear why the UK exemption is limited by reference 10% holding and to trading activities. It creates strange dislocation with the broad exemption for inter-corporate dividends.

S16(2) TCGA where a gain on disposal of shares would be exempt, a loss on disposal is not recognized -> losses on disposal of portfolio holdings of shares or the holding of shares in passive corporations may be recognized (though quarantined).

A participation exemption can be an effective tool against the cascading of losses up a corporate chain. A loss at the bottom of corporate chain will be reflected in reduced value of shares at each link in that chain.

Gains may also be duplicated, but giving stripping effect of dividends, corporate groups generally have a mechanism to resolve issues of double taxation resulting from taxation of gains on the disposal of shares. If losses on the disposal of shares are recognized then corporate groups are likely to plan for duplication.

Corporate groups - use the multiple reflective losses up a corporate chain that are caused by a loss in a corporation at the bottom of that chain. Eg. A holds shares in B and C, B holds shares in D. D incurs a loss, which is reflected in a loss on the shares that B holds in D ad A holds and B. C is profitable and that the corporate tax system permits transfer of losses, whether of a revenue or capital nature.

Loss incurred b D:

MCL -Corporate Taxation


transferred to C B sells share in D, realizing loss that is a reflection of the loss incurred by D. this loss realized by B, can then be transferred to C. A can sell shares in B -> a second reflection of the real loss incurred by D. Loss incurred by A can also be transferred to D.

3 tax losses being transferred to C -> reality: 1 loss

Major benefit of participation exemption is to stops reflective losses arising the first place. Downside: does not tax gains on the disposal of shares. (Because of the issue to gains on the disposal of shares caused by unrealized corporate profits.

Inter-corporate dividends are 95% exempt, 'profits' on the disposal of shares by one corporation in another corporation are also 95% exempt. As with inter-corporate dividends, the exemption for gains on the disposal of shares does not depend on the level of shareholding in the corporation whose shares are disposed of. Expenses incurred in deriving 95% exempt dividends are fully deductible, 5% taxation of dividends being an arbitrary offset for this deduction. By contrast, because it is profits or gains on the disposal of shares that are 95% exempt, costs incurred with respect to the acquisition or disposal of shares that are 95% exempt, costs incurred with respect to the acquisition or disposal of shares are only 5% deductible. Costs result in a loss on disposal of shares, the loss is not deductible at all.

Other expenses relating to the holding of shares (financing & stewardship costs) are fully deductible.

KStG s.8b(2) Profits from the sale of equity in a corporation… shall be ignored when determining income.

5% of the respective profit shall be deemed expenses which may not be deducted as operating costs. Section 3c, Paragraph 1 of the Income Tax Act shall not apply. Reductions in profit arising in connection with the equity specified in Paragraph 2 shall not be considered when determining income.

EstG (Germany) S3 No 40(a)-40% exemption for indiv receiving dividends on shares held as business assets. This 40%
also applies to sales proceeds on the disposal of those shares. However, the system here incorporates a substantial amount of inconsistency by introduction of SH differentiation system in 2009.

EStG Art. 16(1): Income from business enterprises shall also include profits obtained on the sale of the whole business enterprise or a division of the business. A participation in an incorporated company encompassing the total nominal capital shall also be deemed to be a division of the business...

EStG Art. 17(1): Income from business enterprises shall also include profit from the sale of shares in an incorporated company, if the seller had a minimum 1% direct or indirect participation in the capital of the company within the last five

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