QCB Loan Notes and Finance Bill 2010 - Change in Tax Treatment
July 12th 2010
Following the emergency budget on 22 June, the Finance Bill was published last week and whilst there was good news on entrepreneurs’ relief (ER) with the increase to £5 million for the lifetime limit the Bill contained something less welcome with regards to how ER interacts with QCB loan notes.
Position before 22 June 2010
Where shares in a company were sold before 22 June and all or some of the proceeds were in the form of QCB loan notes, the gain attributable to the loan notes would be held over and would crystallise when the loan notes were redeemed in the future at the capital gains tax (CGT) rate prevailing at the time of redemption. ER would only be due at this time if the taxpayer still met the conditions for ER in terms of employment and shareholding, which is unlikely to be the case.
The taxpayer can, however, make a claim under s169R TCGA 1992 to treat the gain as being eligible for ER (assuming all the conditions were met at the time of disposal of the shares). This claim must be made by the first anniversary of 31 January following the end of the tax year in which the shares in the company were disposed of.
If the claim is made, when the QCBs are redeemed in the future that gain (as reduced by 4/9ths due to ER) will be subject to CGT. When those QCB loan notes are redeemed after 23 June, and assuming the higher rate of CGT is payable, the effective tax rate will be 15.55% (ie 28% x 5/9).
Example
On 5 October 2008 Michael sold his personal company and part of the consideration was the issue of QCB loan notes which deferred a gain of £900,000. This disposal met the ER conditions, and Michael claimed for ER to apply. This claim had the effect of reducing the deferred gain to £500,000 (5/9th x £900,000).
On 9 July 2010 Michael redeemed his QCBs, so the reduced deferred gain of £500,000 became subject to CGT. He has sufficient other taxable income to cover the basic rate band so the gain is taxed at 28%. Michael’s CGT liability on the redemption of the QCBs is £140,000, (£500,000 x 28%).
Position on or after 23 June 2010
For share sales completed on or after 23 June 2010 where some or all of the consideration is in the form of QCB loan notes the position is somewhat different when an election is made under the new provisions which will replace s169R TCGA 1992.
If an election is made it means that ER applies but the gain becomes chargeable to CGT at the time of the issue of the loan notes and not redemption. This would be at a rate of 10% if the £5 million lifetime limit is not breached.
If no election is made then the CGT position is the same as before.
Therefore, care will need to be taken when negotiating deals as the vendor could end up with a tax charge with no cash to pay, depending upon the repayment profile of the loan notes. A decision will need to be made between taxing the gain early at 10% or deferring it and paying CGT at up to 28% (or whatever rate is prevailing at the time of redemption).
If you have any queries regarding the above please do not hesitate to contact Craig Hughes on 0115 983 5580 or chughes@edftax.co.uk
