Topical Questions - Capital Gain Tax

In company reorganisations and take-overs, what is the CGT treatment in relation to “paper for paper” transactions?

Relief is provided where shares in a company are disposed of by way of exchange for other shares in the same company; for example, where the shareholder surrenders his/her existing shares in exchange for other new shares. Nothing passes but the shares (“paper for paper”).

The central rule is that the mere exchange of one block of shares for another on a capital reorganisation by the company is not treated for CGT purposes as a disposal of the old shares or an acquisition of the new shares. Instead, the new holding is treated as if it had been acquired at the same time and cost as the original holding was acquired, and a gain or loss on the old shares is not regarded as accruing until the new holding is disposed of in whole or in part. If any cash payment is received as part of the reorganisation it is treated as a part disposal of the shares; if any cash is paid it is treated as additional cost price (or enhancement expenditure).

The foregoing applies to transactions within a single company. Similar rules apply to a share for share exchange in a take-over situation where the acquiring company obtains control.

What is the CGT treatment of capital sums derived from shares (“part disposal”)?

Capital sums derived from shares, with or without any actual disposal of the shares taking place, represent a part disposal of the shares. The following example illustrates how the gain is calculated:

Jim owns 1,000 shares in XY LTD, which he acquired for £2,500. Some time later, there was a rights offer of 1 new share for every 4 held, at a discount of market value. Jim did not take up the additional shares and instead sold his rights to acquire the new shares for £1,200 to a third party. The market value of the shares after the issue was £4 each.

Jim is treated as having made a part disposal out of his holding of 1,000 shares. Jim has 1,000 shares in a company which cost him £2,500. He has received a capital payment out of these shares of £1,200. The capital gain is computed by reference to the capital sum of £1,200 less a proportion of the cost of the shares. The proportion is calculated by reference to the capital sum received and the value of the shares after the payment (i.e. 1,000 x £4 or, £4,000) as follows:

The CGT is therefore on £623 (£1,200 - £577, before indexation, if due). In the event of a future disposal of the shares the balance of the cost to be allowed is £1,923 (£2,500 - £577).

Further examples of part disposals include capital distributions by companies including capital distributions on a winding up or where a cash payment is received as part of a “paper for paper” transaction.