In the previous chapter, we have revised the basic computation of chargeable
gains and how to calculate the CGT payable. In this chapter, we look at shares
and securities held by individuals.
Shares and securities need special treatment because an investor may hold
several shares or securities in the same company, bought at different times for
different prices but otherwise identical.
The rules for shares and securities held by companies are different and are
dealt with later in this Text.
In the next chapter, we will consider CGT deferral reliefs and the CGT
implications of varying a will.
|Chargeable gains and capital gains tax liabilities in situations involving further overseas aspects and in relation to closely related persons and trusts together with the application of additional exemptions and reliefs
|The contents of the Paper F6 study guide for chargeable gains under heading:
|C4 Gains and losses on the disposal of shares and securities
|Gains and losses on the disposal of shares and securities:
|Extend the explanation of the treatment of rights issues to include the small part disposal rules applicable to rights issues
|Define a qualifying corporate bond (QCB), and understand what makes a corporate bond non-qualifying. Understand the capital gains tax implications of the disposal of QCBs in exchange for cash or shares
|Apply the rules relating to reorganisations, reconstructions and amalgamations and advise on the most tax efficient options available in given circumstances
Shares and securities are some of the more common assets held by individuals, and knowing how to compute the gain on their disposal is fundamental to an understanding of capital gains.
This chapter revises the identification rules for individuals and the computation of gains on disposals that were covered in Paper F6. It expands on the rules for rights issues, takeovers and reorganisations. There have been no changes to the rules in 2015/16 from 2014/15.
1 The matching rules for individuals
There are special rules for matching shares sold with shares purchased. Disposals are matched first with shares acquired on the same day, then within the following 30 days and finally with the share pool.
Quoted and unquoted shares and securities present special problems when attempting to compute gains or losses on disposal. For instance, suppose that an individual buys some quoted shares in X plc as follows.
Date Number of shares Cost
5 May 2003 100 150 17 August 2015 100 375
On 15 August 2015, he sells 120 of the shares for £1,450. To determine the chargeable gain, we need to be able to work out which shares out of the two original holdings were actually sold.
We therefore need matching rules. These allow us to decide which shares have been sold and so work out what the allowable cost on disposal should be.
At any one time, we will only be concerned with shares or securities of the same class in the same company. If an individual owns both ordinary shares and preference shares in X plc, we will deal with the two classes of share entirely separately, because they are distinguishable.
Below ‘shares’ refers to both shares and securities.
For individuals, share disposals are matched with acquisitions in the following order.
- Same day acquisitions.
- Acquisitions within the following 30 days (known as the ‘bed and breakfast rule’) if more than one acquisition on a “first in, first out” (FIFO) basis.
- Any shares in the share pool (see below).
The share pooling and matching rules do not apply to employee shareholder shares (see earlier in this Text). In addition, if the individual has a mixture of employee shareholder shares and other shares in a particular company, the individual can decide which of the shares disposed of are to be treated as employee shareholder shares.
The ‘bed and breakfast’ rule stops shares being sold to crystallise a capital gain or loss, usually to use the annual exempt amount and then being repurchased a day or so later. Without the rule a gain or loss would arise on the sale since it would be ‘matched’ to the original acquisition.
|Learn the ‘matching rules’ because a crucial first step to getting a shares question right is to correctly match the shares sold to the original shares purchased.
Exam focus point
2 The share pool
2.1 Composition of pool
We treat any other shares acquired as a ‘pool’ which grows as new shares are acquired and shrinks as they are disposed.
In making computations which use the share pool, we must keep track of:
- The number of shares
- The cost of the shares
2.2 Disposals from the share pool
In the case of a disposal the cost attributable to the shares disposed of is deducted from the amounts within the share pool. The proportion of the cost to take out of the pool should be computed using the A/(A + B) fraction that is used for any other part disposal. However, we are not usually given the value of the remaining shares (B in the fraction). We just use numbers of shares.
In August 2006 Oliver acquired 4,000 shares in Twist plc at a cost of £10,000. Oliver sold 3,000 shares on 10 July 2015 for £17,000. Compute the gain and the value of the share pool following the disposal.
The gain is computed as follows:
|Less cost (working)
|Working – share pool
|Acquisition – August 2006
|Disposal – July 2015
|Anita acquired shares in Kent Ltd as follows:
1 July 2000 1,000 shares for
|11 April 2005 2,500 shares for
|17 July 2015 400 shares for
|10 August 2015 500 shares for
Anita sold 4,000 shares for £16,400 on 17 July 2015.
Calculate Anita’s net gain on sale.
First match the disposal with the acquisition on the same day:
Less cost (1,680)
Next match the disposal with the acquisition in the next thirty days:
Less cost (2,000) Gain 50
Finally, match the disposal with the shares in the share pool:
Less cost (working) (8,414)
Net gain £(50 + 4,296 – 40) 4,306
No. of shares Cost
1.7.00 Acquisition 1,000 2,000 11.4.05 Acquisition 2,500 7,500
17.7.15 Disposal (3,100) (8,414) c/f 400 1,086
3 Alterations of share capital
On an alteration of share capital, the general principle is only to tax gains immediately if cash is paid to the investors.
3.1 General principle
On a reorganisation we must apportion the original base cost of whatever the shareholder had beforehand between the elements of whatever the shareholder has afterwards.
3.2 Capital distributions
Normally a capital distribution is treated as a part disposal of an asset. If, however, the distribution is small (normally taken to mean not more than the higher of 5% of the value of the shares and £3,000) then any gain can be deferred by treating the distribution as a deduction from the cost of the shares for the purposes of calculating any gains or losses on future disposals.
If the taxpayer wants a part disposal (for example to use his annual exempt amount) HMRC will allow this even if the proceeds are small.
S Barr holds 1,000 shares in Woodleigh plc which cost £4,000 in August 2003. The company is now in liquidation and in June 2014 the liquidator made a distribution of 35p per share. The market value of the shares after the distribution was £7,000. In November 2015 S Barr received a final distribution of £7,200.
Show any chargeable gains arising, assuming that there is no part disposal in June 2014.
No gain arises in June 2014 as the distribution in June 2014 is not more than the higher of £3,000 and 5% of the value of the shares: £(350 + 7,000) 5% = £368. The November 2015 distribution is treated as follows.
Less cost £(4,000 – 350) (3,650)
3.3 Bonus issues (scrip issues)
When a company issues bonus shares all that happens is that the size of the original holding is increased. Since bonus shares are free shares, issued at no cost, there is no need to adjust the original cost. Instead the numbers purchased at particular times are increased by the bonus. The normal matching rules will then be applied.
3.4 Rights issues
The difference between a bonus issue and a rights issue is that in a rights issue the new shares are paid for and this results in an adjustment to the original cost.
In an open offer, shareholders have a right to subscribe for a minimum number of shares based on their existing holdings and may buy additional shares. Subscriptions up to the minimum entitlement are treated as a rights issue. Additional subscriptions are treated as new purchases of shares.
|Simon had the following transactions in S Ltd.
1.10.06 Bought 10,000 shares for £15,000
1.2.12 Took up rights issue 1 for 2 at £2.75 per share
14.10.15 Sold 2,000 shares for £6,000 Compute the gain arising in October 2015.
|No. of shares
|1.2.12 Rights issue
Less cost (3,833)
3.5 Sales of rights nil paid
Where the shareholder does not take up his rights but sells them to a third party without paying the company for the rights shares, the proceeds are treated as a capital distribution (see above) and will be dealt with either under the part disposal rules or, if not more than the higher of £3,000 and 5% of the value of the shareholding giving rise to the disposal, as a reduction of original cost (unless the taxpayer chooses to use the part disposal treatment, for example if the gain would be covered by the annual exempt amount).
A reorganisation takes place where new shares or a mixture of new shares and debentures are issued in exchange for the original shareholdings. The new shares take the place of the old shares. The problem is how to apportion the original cost between the different types of capital issued on the reorganisation.
If the new shares and securities are quoted, then the cost is apportioned by reference to the market values of the new types of capital on the first day of quotation after the reorganisation.
An original quoted shareholding of 3,000 shares is held in a share pool with a cost of £13,250.
In 2015, there is a reorganisation whereby each ordinary share is exchanged for two ‘A’ ordinary shares (quoted at £2 each) and one preference share (quoted at £1 each). Show how the original cost will be apportioned.
New holding MV Cost
Ords 2 new shares 6,000 12,000 10,600
Prefs 1 new shares 3,000 3,000 2,650
Total 15,000 13,250
12/15 £13,250 = cost of ordinary shares
3/15 £13,250 = cost of preference shares
Where a reorganisation takes place and the new shares and securities are unquoted, the cost of the original holding is apportioned using the values of the new shares and securities when they come to be disposed of.
For both quoted and unquoted shares and securities, any incidental costs (such as professional fees) are treated as additional consideration for the new shares and securities.
3.7 Takeovers 12/13, 6/11
The special rules on takeovers only apply if the exchange is for bona fide commercial reasons and not for the avoidance of tax.
A chargeable gain does not arise on a ‘paper for paper’ takeover. The cost of the original holding is passed on to the new holding which takes the place of the original holding. If part of the takeover consideration is cash then a gain must be computed: the normal part disposal rules will apply. The paper for paper rules do not apply on a takeover of a company in relation to employee shareholder shares.
If the cash received is not more than the higher of 5% of the total value on the takeover, and £3,000, then the small distribution rules apply and the cash received will be deducted from cost for the purpose of further disposals, unless the taxpayer chooses the part disposal treatment.
The takeover rules apply where the company issuing the new shares ends up with more than 25% of the ordinary share capital of the old company or the majority of the voting power in the old company, or the company issuing the new shares makes a general offer to shareholders in the other company which is initially made subject to a condition which, if satisfied, would give the first company control of the second company.
The exchange must take place for bona fide commercial reasons and must not have as its main purpose, or one of its main purposes, the avoidance of CGT or corporation tax.
Simon held 20,000 £1 shares in D plc out of a total number of issued shares of one million. They were bought in 2002 for £2 each. In 2015 the board of D plc agreed to a takeover bid by S plc under which shareholders in D plc received three ordinary S plc shares plus one preference share for every four shares held in D plc. Immediately following the takeover, the ordinary shares in S plc were quoted at £5 each and the preferences shares at 90p. Show the base costs of the ordinary shares and the preference shares.
The total value due to Simon on the takeover is as follows.
Ordinary 20,000 3/4 £5 75,000 Preference 20,000 1/4 90p 4,500
|Original cost of shares = 20,000 £2 = £40,000
The base costs of the new holdings are therefore:
|Ordinary shares: 75,000/79,500 £40,000
|Preference shares: 4,500/79,500 £40,000
Part of the takeover consideration may include the right to receive deferred consideration in the form of shares or debentures in the new company. The amount of the deferred consideration may be unascertainable at the date of the takeover, perhaps because it is dependent on the future profits of the company whose shares are acquired. The right is valued and treated as a security. This means the takeover rules apply and there is no need to calculate a gain in respect of the right. The issue of shares or debentures as a result of the right is treated as a conversion of the right and, again, no gain arises.
3.8 Interaction with entrepreneurs’ relief
point Entrepreneurs’ relief is discussed in Section 1 of Chapter 13. You may wish to read that first before studying this section.
There may be a problem if the rules on reorganisations and takeovers described above apply and the new shares do not qualify for entrepreneurs’ relief when they are eventually disposed of (for example because the shareholder no longer works for the company or the level of shareholding is too low). In this case, without special rules, any entrepreneurs’ relief accrued on the old shares will be lost.
In this case, the legislation provides that the shareholder can elect to disapply the usual reorganisation or takeover treatment and can claim entrepreneurs’ relief in the year of the reorganisation or takeover. The shareholder will then make a chargeable disposal with proceeds of the shares acquired and costs apportioned as already described.
The election must be made by the same date as the claim for entrepreneurs’ relief. So if the takeover occurs in 2015/16, the claim must be made by 31 January 2018.
4 Gilts and qualifying corporate bonds
Gilts and QCBs held by individuals are exempt from CGT.
4.1 Definitions and treatment
Key term Gilts are British Government and Government guaranteed securities as shown on the Treasury list. Gilt
strips (capital or interest entitlements sold separately) are also gilts. You may assume that the list of gilts includes all issues of Treasury Loan, Treasury Stock, Exchequer Loan, Exchequer Stock and War Loan.
Disposals of gilt edged securities (gilts) and qualifying corporate bonds by individuals and trusts are exempt from CGT. The rules for companies are different, and are explained later in this Text.
Key term A qualifying corporate bond (QCB) is a security (whether or not secured on assets) which:
- Represents a ‘normal commercial loan’. This excludes any bonds which are convertible into shares (although bonds convertible into other bonds which would be QCBs are not excluded), or which carry the right to excessive interest or interest which depends on the results of the issuer’s business
- Is expressed in sterling and for which no provision is made for conversion into or redemption in another currency
- Was acquired by the person now disposing of it after 13 March 1984, and
- Does not have a redemption value which depends on a published index of share prices on a stock exchange.
Permanent interest bearing shares issued by building societies which meet condition (b) above are also QCBs.
4.2 Reorganisations involving QCBs
If a reorganisation involves the acquisition of QCBs, a gain to the date of the takeover is computed but is ‘frozen’ until the disposal of the QCB.
Special rules apply when a reorganisation involves qualifying corporate bonds, either as the security in issue before the reorganisation (the ‘old asset’) or as a security issued on the reorganisation (a ‘new asset’).
Where QCBs are the old asset, the newly issued shares are treated as acquired at the time of the reorganisation, for the then market value of the old asset. This market value is reduced by any money paid to the security-holders, or increased by any money paid by them. If a company holds the QCBs, then the QCBs are treated as sold at the same time for their market value, so as to find the company’s profit or loss.
Where QCBs are the new asset, the chargeable gain which would have accrued if the old asset had been sold at its market value at the time of the reorganisation must be computed and apportioned between the new assets issued. When the QCBs are disposed of, the part of that gain apportioned to them becomes chargeable. However, if that disposal is a no gain/no loss disposal to a spouse/civil partner, the gain does not become chargeable until a disposal outside the marriage. Furthermore, if the reorganisation is followed by the owner’s death while he still owns the QCBs, the gain never becomes chargeable.
QCBs are often used in takeover situations instead of cash where for most shareholders the cash would not be a small capital distribution. This enables the shareholder to defer the gain until the QCBs are disposed of. This is often done over a period of time so as to use the annual exempt amount and any other reliefs available.
Zelda owned 10,000 shares in Red Ltd which she had acquired for £20,000. In July 2014, Red Ltd was taken over by Rainbow plc and Zelda received:
6,000 ordinary shares in Rainbow plc worth £2 per share; and
£9,000 loan stock (which were qualifying corporate bonds) in Rainbow plc worth £4 for each £1 nominal value,
In August 2015 Zelda sold 2,000 shares in Rainbow plc for £2.40 per share, and £3,375 of the loan stock in Rainbow plc for £4.50 for each £1 nominal value.
Show the capital gains implications of the takeover and the subsequent sales.
The total value due to Zelda on the takeover is as follows.
|Ordinary shares 6,000 × £2
Loan stock £9,000 × £4
|The base costs of the new holdings are therefore:
|Ordinary shares: 12,000/48,000 £20,000
Loan stock: 36,000/48,000 £20,000
On the takeover, there is no disposal for CGT on the exchange of Red Ltd shares for the Rainbow plc shares and the loan stock. However, the gain up to the date of the takeover on the loan stock is calculated as follows:
|Market value of loan stock received on takeover
This gain is ‘frozen’.
On the disposal of the shares, a gain arises in the normal way:
|Proceeds 2,000 × £2.40
|Less cost £5,000 × 2,000/6,000
Note that this gain includes the gain up to the date of the takeover and the gain from the date of the takeover.
On the disposal of the loan stock, part of the frozen gain becomes chargeable:
£21,000 × 3,375/9,000 £7,875
The gain on the loan stock sold is exempt from CGT because the loan stock itself are qualifying corporate bonds.
|Takeover with corporate bonds were tested in June 2011 Question 4 Capstan. The examiner commented that ‘there was often confusion as to the treatment of the sale of the corporate bonds. Many candidates who knew that corporate bonds are exempt from capital gains tax went on to calculate a gain on the sale and include it in the taxable capital gains for the year. Also, many candidates were not able to identify the gain on the original shares that was frozen at the time of the paper for paper exchange and then charged when the corporate bonds were sold.’
Exam focus point
4.3 Interaction with entrepreneurs’ relief
The situation in respect of entrepreneurs’ relief available on the frozen gain on QCBs is similar to that involving shares. An election can be made for the gain not to be deferred but instead brought into charge at the time of the takeover, accompanied by a claim for entrepreneurs’ relief. If no election is made and the gain is then deferred under the normal gains rules, the frozen gain will usually not qualify for entrepreneurs’ relief when it comes back into charge on disposal.
|There are special rules for matching shares sold with shares purchased. Disposals are matched first with shares acquired on the same day, then within the following 30 days and finally with the share pool.
|On an alteration of share capital, the general principle is only to tax gains immediately if cash is paid to the investors.
|The special rules on takeovers only apply if the exchange is for bona fide commercial reasons and not for the avoidance of tax.
|Gilts and QCBs held by individuals are exempt from CGT.
|If a reorganisation involves the acquisition of QCBs, a gain to the date of the takeover is computed but is ‘frozen’ until the disposal of the QCB.
- In what order are acquisitions of shares matched with disposals for individuals?
- In July 2006 an individual acquired 1,000 shares. He acquired 1,000 more shares on each of 15 January 2008 and 15 January 2016 in X plc. He sells 2,500 shares on 10 January 2016. How are the shares matched on sale?
- Sharon acquired 10,000 share in Z plc in 2006. She takes up a 1 for 2 rights offer in July 2015. How many shares does Sharon have in her share pool after the rights issue?
- What is a qualifying corporate bond?
Answers to quick quiz
- The matching of shares sold is in the following order.
- Same day acquisitions.
- Acquisitions within the following 30 days.
- Shares in the shares pool.
- 15 January 2016 1,000 shares (following 30 days)
Share pool 1,500 shares
- 10,000 + 5,000 = 15,000 shares
- A qualifying corporate bond is a security which:
- represents a normal commercial loan
- is expressed in sterling
- was acquired after 13 March 1984
- is not redeemable in relation to share prices on a stock exchange