Why a Section 338(g) Election Matters to an American Selling a UK Company
A Section 338(g) election is the one piece of American tax machinery that a US buyer can switch on without your permission, months after your sale proceeds have cleared, and it can convert a settled British capital gain into an ordinary US income tax bill of up to 37 per cent. Furthermore, it costs the buyer nothing to make. Therefore the entire economic burden can land on you.
Most American owners of British companies never hear the phrase until it is too late. You negotiate a share sale, you pay UK capital gains tax, and you assume the matter is closed. Meanwhile, your buyer has until the fifteenth day of the ninth month after completion to file a single form that reshapes your tax year retrospectively. Consequently, thousands of pounds of planning can unravel without a word of warning.
At TaxYork we see this pattern most often when a British trading company with American ownership is acquired by a US corporate group. Specifically, the buyer wants amortisable goodwill. You want a clean capital gain. Those two objectives are not compatible, and the law hands the casting vote to the buyer.
What a Section 338(g) Election Does in Plain Terms
A Section 338(g) election treats a qualifying purchase of shares as though the company itself had sold every asset it owns. Under 26 U.S. Code § 338, the "old target" is deemed to sell all of its assets at fair market value at the close of the acquisition date. Subsequently, a "new target" is deemed to buy those same assets the following morning.
Nothing physically happens. No asset moves, no contract is signed, and no money changes hands beyond the agreed share price. Nevertheless, the American tax code treats the fiction as real for every purpose in subtitle A. Accordingly, gain is computed, a tax year closes, and historic earnings and profits disappear.
Importantly, this election exists only in US law. HMRC recognises no such concept. Therefore the deemed sale generates American consequences with no British counterpart whatsoever, which is precisely why it hurts.
The Qualified Stock Purchase That Triggers It
A Section 338(g) election requires a qualified stock purchase, usually shortened to a QSP. In practice, a corporation must acquire at least 80 per cent of the target's voting power and 80 per cent of its value by purchase within a twelve-month period. Additionally, the acquisition must come from unrelated sellers.
Staged deals still qualify. As the Tax Adviser explains in its analysis of Section 338(g) elections and creeping acquisitions, the acquisition date is simply the first day on which the 80 per cent threshold is crossed. Consequently, a buyer who takes 45 per cent in January and 40 per cent in October has made a QSP in October.
Individuals cannot make the election. Only a purchasing corporation can. However, most US trade buyers and most private equity acquisition vehicles are corporations, so the restriction rules out far less than sellers hope.
Why a UK Limited Company Is a Valid Target
Foreign companies are eligible targets. A British private limited company therefore sits squarely within the rules, provided it is classified as a corporation for American purposes. Notably, a UK limited company is not a per se corporation under the entity classification regulations, which makes its classification a matter of fact rather than assumption.
If you or a predecessor filed a Form 8832 to treat the company as disregarded, there is no target corporation and no qualified stock purchase. Instead, you already own the assets directly for US purposes, and the sale is an asset sale from the outset. Alternatively, if no election was ever filed, the company defaults to corporation status and a Section 338(g) election becomes available to your buyer.
This single fact decides which version of the analysis applies to you. Moreover, it is often buried in a filing made a decade earlier by an adviser who has since retired. Therefore we check it before anything else.
Why the Standard American Advice Is Wrong for a British Target
Search for guidance on this topic and you will read, repeatedly, that the seller is unaffected. That advice is wrong in your situation, and following it is expensive.
The Domestic Rule Everyone Repeats
When the target is an ordinary American company, the logic holds. The deemed asset sale occurs after completion, the corporate-level tax falls on the new target, and the buyer bears the cost of its own election. Hence the familiar contrast with a Section 338(h)(10) election, which requires the seller to sign and therefore gets negotiated properly.
A Section 338(g) election is unilateral. Your buyer files Form 8023 alone, and your consent is neither sought nor required. Consequently, nobody in a domestic deal worries much, because the tax stays with the party who chose it.
What Changes When the Target Is a Controlled Foreign Company
Your British company is almost certainly a controlled foreign corporation, or CFC, because you are a US shareholder owning more than half of it. That status changes everything. A foreign company with no US trade or business pays no American tax on the deemed asset sale directly, so the gain does not stop at the company.
Instead, the gain flows through the anti-deferral regimes to whoever counts as the US shareholder for that short tax year. Crucially, that person is you, not the buyer. The regulations governing the international aspects of section 338 sit behind this result, and practitioner analysis of CFC sales confirms it.
The mechanism is simple once you see it. Because the CFC's tax year closes on the acquisition date, all income through that moment belongs to the pre-closing period. Therefore the seller reports it.
Who Actually Pays After a Section 338(g) Election
Understanding the timing is the whole game. A Section 338(g) election does not create a new taxpayer; it creates a new slice of income and assigns it to the person who held the shares.
The Short Tax Year That Lands on the Seller
A Section 338(g) election closes the CFC's taxable year on the acquisition date. Subsequently, the company begins a fresh year in the buyer's hands. Your inclusion covers everything up to and including the deemed sale, which means the deemed sale gain plus any ordinary trading profits and passive income earned earlier in the year.
Notably, the buyer escapes the pre-closing share entirely. That asymmetry is exactly why buyers like the election and why sellers should price it. Furthermore, the buyer keeps the stepped-up basis and the fifteen-year amortisation of goodwill that follows from it.
Subpart F Income Versus Tested Income
The deemed sale gain splits by asset type. Gain attributable to passive or investment assets generally becomes subpart F income. Meanwhile, gain attributable to the trading business, including goodwill and intellectual property, generally becomes tested income and therefore feeds the net CFC tested income regime under section 951A.
Both routes produce ordinary income. Neither produces a capital gain. Accordingly, income you expected to tax at 20 per cent can arrive at rates reaching 37 per cent, which is the single largest cost of a Section 338(g) election for an individual seller.
The Basis Adjustment That Softens the Blow
You are not taxed twice on the same economics. The inclusion increases your basis in the shares, so your residual capital gain on the stock shrinks by a corresponding amount. However, the relief comes at the wrong rate.
You save tax at capital gains rates on the reduced stock gain. Conversely, you pay tax at ordinary rates on the inclusion. Therefore the swap costs you the spread between the two, and that spread is roughly seventeen percentage points before any credit analysis.
The 2026 Rules That Changed the Arithmetic
Almost every article on this topic quotes figures that expired on 31 December 2025. Consequently, anyone modelling a Section 338(g) election from an older source will reach the wrong number.
NCTI Replaced GILTI at 12.6 Per Cent
The One Big Beautiful Bill Act renamed global intangible low-taxed income as net CFC tested income, or NCTI, for tax years beginning after 31 December 2025. Additionally, it cut the section 250 deduction from 50 per cent to 40 per cent, which lifts the effective corporate rate from 10.5 per cent to 12.6 per cent. Meanwhile, the deemed-paid foreign tax credit improved from 80 per cent to 90 per cent.
Above all, the reform repealed the 10 per cent deemed return on qualified business asset investment. Previously, a capital-intensive company sheltered part of its tested income behind its tangible asset base. Now nothing shelters it, so the entire deemed sale gain that follows a Section 338(g) election feeds straight into the NCTI calculation. The relevant deduction is claimed on Form 8993, and the current instructions for Form 8993 carry the revised percentages.
Why Individuals Fare Worse Than Corporations
Every published worked example on this subject assumes a domestic corporate seller. Such a seller receives the section 250 deduction, claims deemed-paid credits, and often converts the residual stock gain into a fully deductible dividend under sections 1248 and 245A. As a result, the election can genuinely help a corporate seller.
You are not a corporation. An individual US shareholder receives no section 250 deduction, no participation exemption, and no deemed-paid foreign tax credit by default. Hence the identical transaction that saves a corporate seller money can cost you a seven-figure sum.
The Foreign Tax Credit Trap: No UK Tax to Credit
The cruellest feature of a Section 338(g) election is that the extra American income arrives with no foreign tax attached to it.
HMRC Ignores the Deemed Sale Completely
A Section 338(g) election changes nothing under British law, because you sold shares and your company sold nothing. Therefore no UK corporation tax arises on the deemed asset sale, because in the eyes of HM Revenue and Customs no disposal occurred. Your only UK liability is capital gains tax on the share disposal itself.
For 2026-27 the main capital gains tax rates are 18 per cent and 24 per cent. Business asset disposal relief, governed by section 169I of the Taxation of Chargeable Gains Act 1992, now charges 18 per cent on the first £1 million of qualifying lifetime gains following the increase from 6 April 2026. HMRC's own capital gains manual guidance on the relief sets out the two-year qualifying conditions.
Consequently, you pay British tax on one measure of gain and American tax on a different, larger, differently characterised measure. That mismatch is the entire problem.
Section 338(h)(16) Closes the Escape Route
You might hope to treat the deemed asset sale as generating foreign-source income and soak up credits accordingly. Congress closed that door decades ago. Section 338(h)(16) provides that section 338 does not apply when determining the source or character of any item for foreign tax credit purposes.
In other words, your credit position is computed as though you simply sold shares. Notably, the rule carves out gain included as a dividend under section 1248, which preserves one useful planning route. Otherwise, the arbitrage is blocked, and the foreign tax credit rules apply to the transaction you actually did.
Section 901(m) and the Buyer's Diluted Step-Up
Your buyer does not escape unscathed either. A Section 338(g) election on a foreign target is a covered asset acquisition under section 901, so a disqualified portion of the target's foreign taxes becomes non-creditable in later years. Specifically, the disallowance tracks the basis difference created by the election as it unwinds through amortisation.
This matters commercially rather than technically. Because section 901(m) reduces the value of the election to the buyer, a well-advised buyer has already modelled a smaller benefit than you might assume. Therefore you should ask what the election is worth to them before conceding it for nothing.
Section 1248, Section 962 and the Defences That Work
Three provisions decide whether a Section 338(g) election is survivable or ruinous for you. Understanding all three before completion is essential.
Section 1248 Recharacterisation
Section 1248 recharacterises gain on CFC shares as a dividend to the extent of the company's earnings and profits. For an American individual selling a British company, that recharacterisation is usually welcome. The dividend is foreign-source by definition, and a UK company qualifying under the treaty produces qualified dividend income taxed at 20 per cent.
A Section 338(g) election damages this position. Because the deemed sale converts current-year earnings into subpart F income and tested income, the pool of untaxed earnings available for section 1248 treatment shrinks. Consequently, you lose the favourable dividend characterisation on the very earnings that would have carried it.
The Section 962 Election
Once a Section 338(g) election has been made, your strongest defence is section 962. This election allows an individual US shareholder to be taxed on CFC inclusions as though they were a domestic corporation. Therefore the inclusion attracts the 21 per cent corporate rate, the 40 per cent NCTI deduction, and the 90 per cent deemed-paid foreign tax credit.
The arithmetic is transformative. A tested income inclusion taxed at 37 per cent without a section 962 election falls to an effective 12.6 per cent with one, before credits. However, the election carries a second layer of tax when the related earnings are later distributed above the amount already taxed, so it needs modelling rather than reflex.
One warning applies specifically here. The deemed-paid credit depends on foreign tax actually borne by the earnings, and the deemed sale bore no UK tax at all. Accordingly, section 962 delivers the rate reduction reliably but the credit only partially.
Why the High-Tax Exclusion Usually Fails Here
The high-tax exclusion normally rescues American owners of British companies, because UK corporation tax at 25 per cent comfortably clears the 18.9 per cent threshold. Regrettably, it rarely helps against a Section 338(g) election. The deemed sale gain bears no British tax whatsoever, so it cannot clear any effective rate test.
There is a second obstacle. Under the final high-tax exclusion regulations, the election belongs to the controlling domestic shareholders and binds every US shareholder. By the time the short-period return is prepared, control has passed to your buyer. Therefore the right to make or refuse that election should be addressed in the sale agreement, not left to chance. The regulation text itself sits at 26 CFR 1.951A-2.
A Worked Example: A £9 Million London Software Exit
Consider Claire, an American citizen resident in London. She has owned 100 per cent of a UK software company for nine years, with a base cost of £1,000. On 30 April 2026 she sells the shares to a US corporate buyer for £9,000,000. The company holds £1,800,000 of accumulated earnings and profits, and its value sits almost entirely in goodwill and self-developed software.
The UK Position
Claire's chargeable gain is £8,999,000. Business asset disposal relief covers the first £1,000,000 at 18 per cent, producing £180,000. The remaining £7,999,000 attracts 24 per cent, producing £1,919,760. Her total UK capital gains tax is therefore £2,099,760, and that figure does not move whether or not a Section 338(g) election is made.
The US Position Without a Section 338(g) Election
Section 1248 recharacterises £1,800,000 as a qualified dividend, taxed at 20 per cent, giving £360,000. The residual capital gain of £7,199,000 attracts 20 per cent, giving £1,439,800. Net investment income tax at 3.8 per cent on the full £8,999,000 adds £341,962.
Her pre-credit US liability is £2,141,762. However, the £2,099,760 of UK capital gains tax is creditable against the income tax element, which wipes out the £1,799,800 and leaves roughly £299,960 of excess credit to carry forward. Consequently, her only American cash cost is the £341,962 of net investment income tax, which never attracts a credit. Her combined burden is £2,441,722, or 27.1 per cent of the gain.
The US Position With One
Now assume the buyer files Form 8023. The deemed sale produces £7,600,000 of gain inside the company, of which £7,300,000 is tested income and £300,000 is subpart F income. Without a section 962 election, Claire pays 37 per cent on the whole £7,600,000, which is £2,812,000, with no credit available.
Her basis rises by the inclusion, so the residual stock gain falls to £1,399,000 and the section 1248 dividend largely disappears. That residual gain costs £279,800 at 20 per cent plus £53,162 of net investment income tax. Meanwhile, her UK capital gains tax can now shelter only the much smaller stock gain, so approximately £1,820,000 of British tax becomes stranded excess credit. Her American cash cost rises to roughly £2,865,000, and her combined burden approaches £4,965,000.
With a section 962 election the picture improves dramatically. The tested income attracts the 40 per cent deduction and the 21 per cent rate, costing about £919,800, while the subpart F slice costs £63,000. Therefore the election saves her close to £1,830,000. Nevertheless, she remains materially worse off than if the Section 338(g) election had never been made, which is why prevention beats mitigation.
How to Stop a Section 338(g) Election Before You Sign
Every one of these figures is negotiable at heads of terms and unrecoverable afterwards. Therefore the work happens before exchange.
The Consent Covenant
The simplest protection is a covenant that the buyer will not make a Section 338(g) election, or any election with similar effect, without your prior written consent. American-drafted share purchase agreements address the point as standard. British-drafted agreements almost never mention it, which is precisely the gap that catches American sellers of UK companies.
Add a notification obligation as well. Because Form 8023 falls due by the fifteenth day of the ninth month beginning after the month containing the acquisition date, a spring completion produces a deadline in December. The instructions for Form 8023 confirm the timing, and by then you may already have filed the return that now needs amending.
Pricing the Buyer's Step-Up
If the buyer insists, charge for it. The step-up produces fifteen-year amortisation of goodwill and intangibles that reduces the buyer's future NCTI, and that benefit has a calculable present value. Accordingly, a gross-up clause or a straightforward price increase converts your tax cost into consideration.
Failing that, negotiate a tax indemnity covering the incremental US tax and the professional cost of the amended filings. Furthermore, insist on cooperation over the short-period return, because you will need the buyer's asset valuations to compute your own inclusion.
Check the Box Before You Check the Price
Years before any exit, the entity classification decision sets the board. A company already treated as disregarded cannot be the subject of a Section 338(g) election, because there is no target corporation to purchase. Conversely, a company treated as a corporation carries the risk for as long as it exists.
Neither choice is universally right. Disregarded status makes UK corporation tax creditable on your personal return but exposes trading profit annually. Corporation status defers, but it invites the CFC regimes and this election. Therefore the decision belongs in a planning conversation, not a filing cabinet.
How TaxYork Can Help
We prepare American and British returns for company owners on both sides of the Atlantic, and we read share purchase agreements before they are signed rather than afterwards. Specifically, we model the sale under both outcomes, quantify the exposure, and give your corporate lawyers the exact covenant wording to insert.
Our work covers the US tax return preparation that follows a disposal, including the short-period Form 5471, the section 962 computation and Form 8993. Additionally, we handle the treaty and foreign tax credit analysis that determines how much of your British tax survives, and the foreign account reporting that sale proceeds invariably trigger. For owners still some distance from an exit, our cross-border planning service addresses entity classification while the choice remains open.
Professional guidance on these provisions is available through the ICAEW technical tax resources, the Chartered Institute of Taxation and the AICPA tax section. Policy background sits with the US Treasury tax policy office.
Conclusion
A Section 338(g) election is the rare tax provision that lets a stranger increase your bill after the deal has closed. For an American individual selling a British company, the consequences are ordinary rates instead of capital rates, stranded foreign tax credits, and a lost section 1248 dividend. Moreover, the British side of the ledger does not move at all, so there is no offsetting relief.
The defences exist and they work, but they work in a particular order. Prevention through a consent covenant beats mitigation through section 962, and section 962 beats doing nothing by a wide margin. Ultimately, the decision that matters most is taken before you sign, not when the form is filed nine months later.
Contact Us
If you are approaching a sale, or a US buyer has already acquired your company, speak to us now rather than at filing season. You can book a consultation with our cross-border team, email hello@taxyork.com, or telephone 020 3488 8606.
Disclaimer
This article provides general information about US and UK tax rules and does not constitute tax advice. Tax treatment depends on your individual circumstances and on legislation that changes frequently. You should obtain professional advice before acting on any point discussed here.