Tax rollover applied to share for share exchange despite tax saving motive

The Upper Tax Tribunal (UT) rejected arguments raised by HM Revenue & Customs (HMRC) that tax liabilities arose from the sale structure.

Experts at Pinsent Masons said the tribunal’s decision provides useful insights for other businesses.

In this case, Euromoney negotiated terms with a third-party buyer to buy its shares in two joint venture companies.

The original terms of the deal involved some of the consideration being in cash and some an exchange of shares. Before the deal was finalised, however, Euromoney’s tax director identified that the sale of one of the classes of shares for cash – preference shares with no dividend rights – would not qualify for exemption from tax under the substantial shareholdings exemption (SSE). Euromoney therefore requested an adjustment to the sale structure, such that this class of share was instead exchanged for redeemable preference shares.

Under the revised sale structure, the exchange of the shares for redeemable preference shares would be treated as a rollover for capital gains purposes and, once the preference shares had been held for at least 12 months, the subsequent redemption for cash would qualify for SSE. The buyer agreed to restructure the transaction.

Euromoney applied to HMRC for clearance that the transaction would be treated as a share for share exchange, but the transaction completed before HMRC replied. When HMRC did reply, it refused clearance.

HMRC subsequently enquired into Euromoney’s tax return and issued a closure notice treating the entire transaction, not just the preference share element, as a taxable disposal. It did so because it considered that an anti-avoidance provision was triggered which applied to arrangements with a tax avoidance main purpose. Euromoney appealed and the matter was considered by the first-tier tax tribunal (FTT). The FTT found in Euromoney’s favour. It found that the “arrangements” were the whole share for share exchange and the subsequent holding of the preference shares for 12 months. Though it considered that there was a tax avoidance purpose of those arrangements, it determined that was not a “main purpose” of the transaction.

HMRC appealed to the UT on two grounds. Firstly, that the FTT had erred in its approach to identifying the scope of the arrangements; and secondly that the FTT’s decision had been irrational, in the sense that it had taken irrelevant factors into account in reaching its conclusions on the identification of Euromoney’s purpose.

The UT dismissed HMRC’s appeal on both grounds, upholding the FTT decision. The UT found HMRC’s arguments “over-complicated and apt to confuse” in respect of the approach it said should be taken to the interpretation of the anti-avoidance rule in section 137 of the Taxation and Chargeable Gains Act 1992.

The tribunal accepted that there hasn’t previously been significant judicial comment about the application of those rules. However, it concluded that this was because the words of the statute “set out a straightforward test”.

The UT confirmed that the test first requires consideration of whether the exchange forms part of a scheme or arrangements and, if so, what the scheme or arrangements consist of. It said those are questions of fact to be determined by the FTT.

The UT had found HMRC’s arguments unclear, but HMRC appeared to suggest that the FTT should have considered every possible permutation of scheme or arrangement and that only one of them would have to have a main purpose of tax avoidance for the transaction to be subject to tax liabilities. The UT declined to adopt that approach and found nothing irrational in the FTT’s finding that the exchange encompassed the totality of the arrangements.

Richard Croker, corporate tax expert at Pinsent Masons, said: “It is a useful decision on the meaning of arrangements being correctly applied to the overall transaction not an isolated aspect of it. However, taxpayers should take note of the risks of proceeding to complete a transaction before a section 138 clearance is issued, even where you expect HMRC not to object.”

The second question in the statutory test applies if the FTT finds that the exchange does form part of a scheme or arrangement. This question is whether a main purpose of the scheme or arrangement is avoidance of a liability to capital gains tax or corporation tax. The UT again considered that this is a question of fact for the FTT to determine. The UT advised that although the purpose of individual steps within the scheme or arrangements may be relevant, the job of the FTT is to determine the purpose or purposes of the overall scheme or arrangements.

HMRC sought to argue that the FTT had taken into consideration irrelevant facts in determining the purpose of Euromoney’s arrangements, despite having encouraged the FTT to take into account matters outside of the witness evidence. However, the UT found that the FTT had been entitled to take into account these matters, which included the relative size of the tax charge when compared with the size of the consideration as a whole, which was less than 5%. It said the FTT was also entitled to infer that Euromoney’s failure to identify the potential downside of the structuring – i.e. that the whole transaction may fall foul of the anti-avoidance provision – and low overall amount of tax-specialist time and effort spent on the transaction were indicators that Euromoney did not consider the tax saving particularly important in the context of the whole transaction.

In this case, both parties were content to proceed on the basis that the consideration of purpose should involve only a subjective test. As a result, the UT did not express a view as to whether this was correct or whether objective matters ought to be considered in other cases.

Jake Landman, tax disputes expert at Pinsent Masons, said: “Given the absence of significant precedent on the application of this purpose test, it is useful to see how the UT has approached this question. Taxpayers wishing to rely on the absence of an avoidance purpose will take some comfort from the fact that a clear motive of saving tax was not sufficient to cause the transaction to fail to be treated as an exchange.”

“In some ways it is a surprising case for HMRC to have taken since it involved structuring what was accepted by all parties to be a fully commercial transaction in a tax efficient manner. Although HMRC stated that the active change of structure to accommodate the seller’s tax position was not the main thrust of its argument, they did concede that the existence of correspondence around that change of structure made it ‘easier to prove’. However, ultimately, this has not proved enough for HMRC to win the argument about purpose,” he said.

Richard Croker added: “Taxpayers who are structuring their corporate disposals can take some comfort from the finding of the FTT, now endorsed by the UT, that tax avoidance, while present in the detailed implementation of particular steps, was not a main purpose in the arrangements as a whole.”