Article

Unexpected changes

Key points

• Capital gains tax relief on disposals to an employee ownership trust will reduce from 100% to 50% with effect from 26 November 2025.
• Sales to EOTs will no longer qualify for business asset disposal relief or investor’s relief.
• A new anti-avoidance rule for share exchanges and company reconstructions removes the commercial purpose test.
• A measure will prevent avoidance of the capital gains tax rules for non-residents who hold shares in property-rich companies by using ‘cell companies’.
• Ahead of the Budget on 26 November, there had been relatively little speculation around changes to capital gains tax (CGT). Significant changes regarding rates (increasing the main rate from 20% to 24%) and reliefs – increasing business asset disposal relief (BADR) from 10% to 18% from April 2026 and new requirements for employee ownership trusts (EOTs) – had already been introduced at the last Budget and, other than a potential exit charge, speculation regarding CGT was minimal.
• As it happened, an exit charge did not materialise, but some significant, perhaps less expected, changes were announced.
• Sales to employee ownership trusts
• In a rather surprising move, the complete relief from CGT for sales of trading companies to an EOT was repealed for disposals on or after 26 November 2025. Instead of the sale being treated as a no gain, no loss transaction, the chargeable gain is now reduced by 50%, giving an effective rate of 12% (on the basis that the current main rate of CGT is 24%). This might still seem quite generous, but the issue is going to be whether vendors will be able to fund the CGT payment, even at the reduced rate, when it falls due by 31 January following the end of the tax year of disposal. In our experience, many EOT disposals are funded out of current cash reserves of the company and future profits, rather than third party finance from banks. For example, if the proceeds are being paid over, say, ten years at 10% a year, but the vendor has to pay a tax bill of 12% when they have only received one instalment of the proceeds, they may not be able to pay the tax out of their existing savings.
• This may lead to more EOT sales being partly funded by external finance – in our experience more banks are becoming comfortable with the EOT model. Alternatively, it should be possible to pay the CGT liability in instalments under TCGA 1992, s 280 where the deferred consideration period is more than 18 months and the CGT is paid within eight years.
• Sales to an EOT will not be eligible for BADR or investors relief, either. And if the sale is at a loss (which seems unlikely), no allowable loss arises, as the disposal is treated as being a no gain, no loss transaction.
• The trustees’ base cost for the shares is arrived at by deducting the 50% of the gain that is not chargeable from the amount actually paid. In effect, this means that the trustees’ base cost is 50% of the price paid plus 50% of the original base cost of the shares.
• This measure is anticipated to raise £185m in 2026-27, £775m in 2027-28, rising to £985m in 2030-31. To be frank, most observers consider that this measure will materially reduce the number of sales to EOTs, particularly in view of the tax payment issue outlined above, so it is difficult to give any real credence to these figures.
• What we do expect to see as a result of these changes is a greater proportion of EOT sales being undertaken for commercial reasons and with a long-term view of employee ownership, rather than simply being driven by a tax exemption. Given that this has been the policy intention by the government since the inception of EOT relief in 2014, it is perhaps not too surprising that the complete relief has been reigned in.
• Anti-avoidance: Company reconstructions
• The biggest change, from the perspective of those of us who regularly carry out corporate reconstructions, is a completely new anti-avoidance rule for share exchanges and schemes of reconstruction, replacing the TCGA 1992, s 137(1). This came as a surprise to most of us but was, with hindsight, perhaps inevitable following HMRC’s defeats in Wilkinson (TC8887) and Delinian Ltd (formerly Euromoney Institutional Investor plc [2023] EWCA Civ 1281 in 2023. In some ways, the question might be: what took it so long?
• The new rule ‘applies in respect of arrangements relating to an exchange or scheme of reconstructions as regards to which section 135 or 136 applies if the main purpose, or one of the main purposes, of the arrangements is to reduce or avoid liability to CGT or corporation tax’.
• Commercial purpose test
• The first thing to note is that the commercial purpose test has now disappeared, which is a welcome change. We have always taken the view that protection of the exchequer should be concerned with whether people are trying to avoid tax, and that there is no reason why HMRC should be policing the commerciality of the transactions proposed by business owners. Indeed, the commercial purpose test was removed from the transactions in securities rules in 2010 and so, again, we wonder why it took so long to remove it from these rules. This has been a particular problem since the large-scale change in the personnel of the clearance unit around 2018-19, as the focus in recent years has often been on whether a transaction is commercial.
• We cannot criticise the clearance unit for concentrating on an important element of the anti-avoidance rule, but it was particularly unfortunate that no one in the unit really seemed to have a proper grasp of what a commercial transaction is. Our experience, and that of many other practitioners with whom we have spoken, has been that the most difficult cases in terms of obtaining pre-transaction clearance in recent years have all been about whether the transaction was commercial, particularly when the commercial element was divorced from the actual business of the companies concerned, so this is a very welcome change. We suspect that the clearance team feel the same way. That said, it still has a role in applying the similarly worded tests for stamp duty purposes (FA 1986, s 75(5)(a) and s 77(3)(c)), so the rule is still there to cause us all headaches into the foreseeable future.
• Part of a scheme to avoid tax
• The second significant change is that the new rule does not require the exchange or scheme of reconstruction to be ‘part of’ a scheme or arrangements to avoid CGT or corporation tax. This is where HMRC came unstuck in the cases cited above, as in both cases the transaction was an exchange, and elements were inserted into those exchanges to reduce the tax burden, so the tax avoiding elements were part of the exchange, rather than the exchange being part of the tax avoiding arrangements. The new test, instead, simply looks at whether there are elements in an exchange or reconstruction that have a tax avoidance purpose.
• It has been suggested that the new rule, which applies if one of the purposes ‘is to reduce or avoid liability to capital gains tax or corporation tax’, is wider than the old test of whether one of the purposes is ‘avoidance of liability to capital gains tax or corporation tax’. Our view is that this is just a reformulation of the same test and has the same scope.
• HMRC will be able to counteract any reduction or avoidance of CGT or corporation tax by making such adjustments as are ‘just and reasonable’, including disapplying s 135 or s 136 ‘in so far as is required to counteract the reduction or avoidance’. We read this as giving HMRC the power to eliminate ‘inappropriate’ tax advantages, while leaving the favourable tax treatment for share exchanges or schemes of reconstruction in place for taxpayers who are not avoiding tax, and for those that are, in so far as it is appropriate that they should still have that favourable tax treatment. For example, in the Wilkinson case, Mr and Mrs Wilkinson gave shares to each of their daughters as part of arrangements to obtain entrepreneurs’ relief on a further £30m of proceeds from the transaction. We believe this new rule would have allowed HMRC to deny the daughters any relief by treating their exchange of newly acquired shares as a disposal, rather than as a reorganisation. Similarly, in Delinian, where US$21m of the proceeds of the sale of shares was sheltered from corporation tax by arrangements designed to access the substantial shareholding exemption, HMRC would have been able to deny share exchange treatment on that part of the exchange transaction.
• Under the old rule, relief would have been denied to all of the vendor shareholders in Wilkinson and in respect of all the shares that were exchanged in Delinian. So the ‘cherry picking’ approach in the new rule effectively nullifies the First-tier Tribunal decision in Coll (TC28), as well.
• Other points to note
• The other significant change is that there is no longer an exception for shareholders with 5% or less of the ordinary share capital, or of any class of ordinary share capital, of the company. The new rule can apply to remove tax benefits from minority shareholders, which extends the scope of the need for clearances in cases where there are such minority shareholders in a company.
• The necessary adjustments are to be made by an assessment or the modification of an assessment. This rule refers to adjustments being made ‘whether or not by an officer of Revenue and Customs’, which might seem odd at first glance. However, this is probably to allow assessments or amendments to be made automatically, rather than necessarily needing human intervention. We understand that this is a standard form of wording now.
• Finally, it is interesting that a new clause is inserted into the clearance rule (TCGA 1992, s 138) stating that ‘references to shares or debentures include references to any interests or options to which this Chapter applies by virtue of section 135(5), 136(5) or 147’. This concerns interests in companies without share capital, as the share exchange and reconstructions provisions also apply to such companies. We have done several transactions in the past involving companies without share capital and have obtained clearance under s 138 without demur from HMRC, so it seems slightly odd, at first glance, that this new clause is needed. However, we think it is simply to reflect the fact that s 138(1) is being amended so that the phrase ‘the issue’ is changed to ‘the issue of shares or debentures mentioned in s 135(1) and s 136(1)’.
• The rule has immediate effect, as it applies ‘in relation to arrangements involving an issue of shares in, or debentures of, a company on or after 26 November 2025’. However, there is a transitional rule whereby, if clearance had already been granted before that date, the transaction must complete before 26 January 2026. If the clearance application was made before 26 November but clearance was granted at a later date, the transaction must be completed within 60 days of the clearance being granted.
• There are virtually identical changes to the anti-avoidance rules for corporate gains in TCGA 1992, s 139(5) and for reconstructions of collective investment schemes (TCGA 1992, s 103G, s 103H or s 103I), the only difference being that the new rule applies ‘if the main purpose, or one of the main purposes, of the arrangements is to reduce or avoid liability to capital gains tax, corporation tax or income tax’, reflecting the wider scope of those provisions.
• The measures are expected to increase the tax yield by £20m a year from 2026-27 onwards.
• There is, unfortunately, a glaring omission from the draft legislation, as no changes are made to the parallel legislation relating to corporate intangibles in CTA 2009, s 818 (company reconstruction involving transfer of business) and s 832 (genuine commercial transaction requirement and clearance). This means that, for corporate transactions involving the transfer of chargeable intangible assets from one company to another, we still have to consider whether the transaction is being carried out for genuine commercial reasons and does not ‘form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to corporation tax, capital gains tax or income tax’ (CTA 2009, s 831(1)).
• It is not clear whether this is an accidental omission or an intentional further divergence between the two sets of rules since the corporate intangibles regime was enacted in FA 2002. We had a similar situation with the degrouping charge changes for capital gains purposes in FA 2011, which were not mirrored – and are still not fully mirrored – in the corporate intangibles rules. Like many observers, we find it ridiculous that two regimes that were intended to apply in very similar situations, but to different types of asset, have been allowed to diverge like this, and we can only hope that this is an omission and not an intentional difference between the two regimes.
• Incorporation relief
• The relief from CGT for incorporation of a business by individuals (either as sole traders or as partners in a partnership) under TCGA 1992, s 162, does not currently need to be claimed, it is simply given automatically and, if not required, must be disclaimed under s 162A. There was, however, an announcement on Budget day that the transferors of businesses on incorporation will have to claim the relief, giving ‘brief details of the transaction, the tax computations and the type of business transferred’.
• No draft provisions have been published but we are told that the new rule will apply for business transfers on or after 6 April 2026 and that s 162A will be repealed.
• We assume that this new requirement is partly in response to HMRC’s concerns over tax avoidance on the incorporation of property portfolios, promoted by entities such as Property118 and lesstax4landlords.com, which many readers will have seen in the tax press in recent months. This requirement to claim incorporation relief will alert HMRC to cases where it might need to consider further scrutiny of the transaction and its tax consequences. Many of these schemes involve transferring only the beneficial interests in property into the company, leaving the legal interests and the associated mortgages with the transferors. In general, our experience is that HMRC does not question the availability of the relief itself, but is concerned with the other tax issues following incorporation, such as extraction of funds for the shareholders to pay the mortgages that were not transferred to the company.
• The policy paper suggests that this will not generate any extra tax in the short term but that there will be an extra £110m CGT in 2029-30 and £115m in 2030-31. This might seem somewhat bizarre, at first glance, but our guess is that this is the estimated yield from compliance reviews following incorporation, which always take a few years to come to fruition.
• Non-resident capital gains
• This measure is designed to prevent avoidance of the CGT rules for non-residents who hold shares in property-rich companies by using ‘cell companies’. These are companies that are broken up into individual ‘cells’, such that each shareholder has complete control over their own cell, independently from other shareholders. Presumably (from our reading of the draft legislation), the shareholders were able to argue that the cell company as a whole was not a property-rich company, because the company itself did not derive 75% of its value from UK land and property. The draft new rule treats each individual cell as if it were a separate company, to prevent this form of avoidance. This amendment comes into effect in relation to disposals made on or after 26 November 2025.
• The policy paper also says that the measure is intended to ‘clarify when certain individuals have to make double taxation treaty claims’. Draft legislation was not published but we are told that the change will be achieved by ‘formalising’ (HMRC’s word) an existing extra-statutory concession, and will have effect for companies from 1 April 2026 and for individuals from 6 April 2026.
• Intriguingly, while this is obviously an anti-avoidance measure, the policy paper says that the tax yield will be negligible. Obviously, a great use of parliamentary time.
• Capital gains tax gift relief
• Hidden in the depths of the OOTLAR (overview of tax legislation and rates) we also found this statement: ‘CGT relief for gifts of business assets (2.19). The formula that restricts gift holdover relief on the disposal of qualifying shares or securities will be modernised to include assets within the intangible fixed assets regime, or that qualify for the substantial shareholding exemption.’
• We believe this refers to a little-known technical problem with the restriction for gift relief (TCGA 1992, s 165), where the relief is restricted for gifts of shares of a company where the company’s chargeable assets include assets that are not used for the purposes of the trade (TCGA 1992, Sch 7 para 7). The amount by which the relief is restricted takes into account only the chargeable assets of the company.
• In many cases, however, a trading company’s main asset will be goodwill and, if the trade started on or after 1 April 2002, goodwill is not a chargeable asset of the company, as it is dealt with separately under the corporate intangible regime (CTA 2009, Part 8). This means that, if the company has even a very small level of non-business chargeable assets, the restriction on gift relief is completely out of proportion to the actual level of non-business assets of the company. The CIOT made representations on this point back in 2003 (see tinyurl.com/ciotcgt2003rep).
• We have always assumed that this was a technical oversight and that Sch 7 would have been amended back in 2002 if the issue had been noticed. We hope, therefore, that when the restriction is ‘modernised’ the amendment will be deemed always to have had effect. Otherwise, taxpayers who have made gifts of shares may still be unwittingly at risk.
• We would like to thank friends and colleagues who have contributed their thoughts on the changes discussed above. There are too many to name individually but their input into our understanding of the new rules has been invaluable. 

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