The substantial shareholding exemption

Where the conditions for the SSE are met but the transaction results in a loss, that loss is not allowable for corporation tax purposes and therefore cannot be used to reduce a company's taxable profits.

The SSE actually consists of four separate but similar exemptions. Here we look at the main exemption, which is referred to as "the SSE", and give a brief overview of the three subsidiary exemptions.

Where the SSE applies, it is automatic and does not depend on the company making an election.

The SSE

The key conditions for the SSE to apply relate to (i) the shareholding held in the company being invested in (the target) by the investing company (the seller), and (ii) the trading status of the target and the target's group.

This guide refers to a 'seller', although the SSE could apply whenever there is a disposal of shares and this does not have to be on an outright sale. For example, a liquidation of a subsidiary company would usually result in a disposal of the shares in that company to which the SSE may apply.

The seller's shareholding in target (the "shareholding condition")

The seller must:

• hold an interest of at least 10% of the target's ordinary share capital;
• be beneficially entitled to at least 10% of the profits available for distribution to ordinary shareholders as well as certain loan note holders; and
• on a winding up, be beneficially entitled to at least 10% of the assets of the target available for distribution to such ordinary shareholders and certain loan note holders.

The seller must hold or have held the interests described above throughout a 12 month period beginning not more than six years before the disposal of the relevant shares in target. For example, for a disposal in July 2022 to qualify for SSE it would have been sufficient for the 10% interest to have been held for the 12 months from July 2016 to July 2017. This means that from July 2017 the seller could hold an interest of less than 10% and the SSE may still apply on its disposal, allowing for a stake in a subsidiary to be sold down gradually.

There are situations where factors other than the seller's period of ownership may be relevant, for example the holding period of the seller may be able to be extended where:

• the shares had previously been held by another company within the seller's group; and/or
• the target is carrying on a trade that had previously been carried on by the seller or another member of the seller's group.

Qualifying institutional investors (QIIs) are not required to hold the 10% interest in a target.  Where at least 25% of the ordinary share capital of the seller is owned by one or more QIIs the condition relating to the seller's shareholding is met if:

• the seller holds an interest in ordinary shares in the target and the acquisition cost of these shares was at least £20,000,000; and
• the seller's beneficial interest in the company is proportionate with such shares.

Conditions relating to the target (the trading condition)

From the start of the latest 12-month period that is used for the purposes of determining whether the shareholding condition applies, the target must be a "qualifying company."

A target is a qualifying company if it is a trading company or the holding company of a trading group. A trading company is a company carrying on trading activities and activities other than trading activities are not carried on "to a substantial extent". Broadly, for these purposes, HMRC considers the term 'substantial' to mean more than 20%, although HMRC has cautioned that it will consider the facts and circumstances of each case when determining whether a company carries on non-trading activities to a substantial extent.

Similarly, a trading group is a group where one or more of the members of the group carry on trading activities and the activities of all of the members of the group, when taken together, do not include to a substantial extent activities other than trading activities.

Prior to 1 April 2017, the target company also had to be a qualifying company immediately after the disposal of its shares. This position caused some practical difficulty in that the seller may have been required to rely on a third party buyer's operation of the target company following the disposal. From April 2017 this condition is only relevant where:

• the relevant buyer and the seller are connected; and/or
• the target is carrying on a trade that had previously been carried on by the seller or another member of the seller's group and the seller has not held the target shares for the requisite 12-month period.

In certain circumstances the trading activity of a joint venture company may also be assigned to a target that is a joint venture partner. This allows a target, which may otherwise be carrying on an 'investment' activity, to qualify as a trading company on the basis of the trade being carried on by the joint venture company itself.

SSE subsidiary exemption: assets related to shares

Where certain conditions are satisfied, this provides a subsidiary exemption for assets related to shares, for example options.

SSE subsidiary exemption: disposal of shares where SSE conditions have previously been met

The purpose of this subsidiary exemption is to allow the SSE to be available where a target has ceased trading prior to the disposal of its shares. The exemption would apply to any form of disposal but in practice is often claimed in relation to the liquidation of a company.

The key conditions for this subsidiary exemption to apply are:

• the shareholding condition is met at the time of the disposal;
• following the disposal, if the exemption did not apply, a chargeable gain or allowable loss for corporation tax purposes would accrue to the seller;
• the seller is UK resident at the time of the disposal or the gain would attach to a UK permanent establishment;
• there is a time within the two years prior to the disposal when a gain on the sale of target shares would not have been a chargeable gain, and a loss would not have been allowed to reduce corporation tax profits;
• there was a time within the two year period prior to disposal that the target was controlled by the seller or, broadly, by persons connected with the seller.

SSE subsidiary exemption: QIIs (the QII exemption)

The QII exemption applies to disposals occurring after 1 April 2017. The broad purpose of introducing this new subsidiary exemption was to improve the attractiveness of the UK to institutional investors. As such, this subsidiary exemption is limited to disposals where at least 25% of the ordinary share capital of the seller is owned by one or more QIIs.

QIIs include: trustees or managers of a registered pension scheme, certain companies carrying on life assurance business; persons exempt from corporation or income tax on the basis of sovereign immunity; charities; investment trusts; authorised investment funds; and trustees of certain exempt unauthorised unit trusts.

The key benefit of the QII exemption is that it can apply to exempt a gain where the target is not a trading company, or the holding company of a trading group.

The QII exemption operates to exempt a chargeable gain where immediately before the disposal, 80% or more of the seller's ordinary share capital is owned by a QII.

If immediately before the disposal, the QII owns at least 25% but less than 80% of the seller's ordinary share capital, any chargeable gain will be reduced by the percentage of the seller's ordinary share capital, which is owned by the QII, for example: a gain accruing to a seller that was 60% owned by a QII would be 40% chargeable.

Application of the exemption may be more complicated if the QII has an indirect shareholding in the seller, for example through intermediate holding companies.