IR40                                       29 November 1994

         CAPITAL GAINS: COMPANIES LEAVING GROUPS

The Chancellor proposes in his Budget to make changes  to
protect the capital gains charge which may arise  when  a
company leaves a group.

The  Chancellor's intention is to close a loophole in the
so  called degrouping charge.  This charge may apply when
a  company  leaves  a group holding  an  asset  which  it
acquired  from  another company within that  group.   The
changes  proposed  would apply when a  company  leaves  a
group on or after today.

                    NOTES FOR EDITORS

1.    The  definition of a group of companies for capital
gains  purposes  is set out in Section  170  Taxation  of
Chargeable  Gains  Act (TCGA) 1992.  A  group  comprises,
broadly,  a  parent company and all its 75% subsidiaries,
together  with their 75 per cent subsidiaries and  so  on
until the parent is not entitled to more than half of the
subsidiary's profits and assets.

2.    Special  rules exist to ensure the  taxation  of  a
group  is  broadly  similar to that of  a  single  multi-
divisional company.  Under Section 171 TCGA 1992 an asset
can  be  transferred within a group without a tax  charge
arising (a "no gain/no loss" transfer).  Since the  asset
remains in the same economic ownership, no tax charge  on
transfers within the group is appropriate.

3.    This  provision was exploited to  avoid  a  capital gains
charge when a company in a group wanted to dispose of  an asset.
This was done by a device known  as  the "envelope trick".  This
trick worked by transferring  the asset  to a shell subsidiary (the
envelope) which  issued new  shares  in return for that asset.  The
group  rules prevented a tax charge arising on this transfer.  The
subsidiary company containing the  asset was then sold. No taxable
gain arose on the sale of the shares in that company since, for
capital gains purposes, their   cost  was  equal  to  the value  of
the   asset transferred and was also equal to their sale price.

4.    Legislation  was introduced in 1968  to  stop  this
avoidance.   It  is now in Section 179 TCGA  1992.   This
legislation  created a degrouping charge when  a  company
left  a group holding an asset which had been transferred
to  it from another company in that group in the previous
six  years.  Transfers within the group were still at "no
gain/no  loss" but a degrouping charge applied  when  the
economic  ownership of that asset changed.   This  charge
reflects  the  gain arising from the time the  asset  was
first  acquired by a company in the group  up  until  the
time  it  was transferred to the company now leaving  the
group.

5.   The degrouping charge applies subject to a number of
conditions.  Under Section 179(2) TCGA 1992, there is  no
charge when both companies involved in the transfer of an
asset  are associated companies leaving the group at  the
same time.  Any gain on such an asset should be reflected
in  the  value of the shares sold when the two  companies
leave the group.

6.   This let-out has recently been exploited to recreate
the  envelope  trick,  but in a new variation  where  the
envelope   consists  of  two  companies.    One   company
transfers  the  asset  to  a shell  subsidiary  and  both
companies then leave the group but in such a way that the
group  does  not in fact lose economic ownership  of  the
degrouped companies.  Such artificial degrouping  can  be
achieved   by,   for   example,  an   outside   financial
institution  subscribing  for new  shares  in  the  shell
company. These new shares would carry negligible economic
rights  but would cause the two companies to be degrouped
for  capital gains purposes.  No degrouping charge arises
because of the let-out for associated companies leaving a
group  at  the  same time.  When the shell subsidiary  is
subsequently  sold,  any  gain  arising  is  not  taxable
because it is leaving a group which is no longer the same
as the one within which it originally acquired the asset.

7.     The  proposed  legislation  will  stop  this   new
exploitation  and  ensure  that  the  degrouping   charge
applies,  as intended, when an asset leaves the  economic
ownership  of  a  group.  It will do this by  effectively
treating the original group and the group formed  by  the
artificial   degrouping  as  one  and   the   same   when
considering  whether  the  degrouping  charge  provisions
apply.

8.   This measure, which will apply when a company leaves
a  group  on  or after today, will protect the Exchequer.
If  not closed, this loophole would result in the loss of
a significant amount of tax.