Tax planning and main purpose

The Court of Appeal has held that arrangements entered into as part of a larger share exchange to ensure the part of the consideration was received in a tax efficient manner did not prevent the application of the roll over provisions in TCGA 192 s.135: HMRC v Delinian Ltd (formerly Euromoney Institutional Investor Plc) [2023] EWCA 1281. The exchange as a whole was entered into for bona fide commercial reasons and it could not be said that the more limited scheme or arrangements to avoid tax formed part of that exchange.

The Court of Appeal forcefully made the point that it was clear from its wording that section 137 did not apply to all tax avoidance. It was only tax avoidance that was a main purpose of the exchange as a whole that will taint an exchange.

More generally, the decision highlights the importance of the findings of fact by the FTT in cases involving the subjective intention of the taxpayer in tax avoidance scenarios and the difficulty of overturning such findings (based in large part on the credibility of witnesses) on appeal.

Background

Euromoney was a joint venture investor in a company, CDL. An agreement was reached to sell its shareholding in CDL for a mixture of shares and £21m cash. After the agreement in principle had been reached, Euromoney realised that it would be more tax efficient to replace the cash element with an issue of preference shares in the buyer. This was because its holding in CDL did not benefit from the substantial shareholdings exemption (SSE). However, if it received preference shares in the buyer with the benefit of roll over relief under s.135, held them for a year and then disposed of them, that sale would benefit from the SSE. Accordingly, it requested that the deal be structured in this way and the buyer was willing to accommodate that request.

HMRC, however, took the view that, on the facts of this case, the roll over provisions in s.135 were prevented from applying by TCGA 1992 s.137, which provides that: "...neither section 135 nor section 136 shall apply to any issue by a company of shares in or debentures of that company in exchange for or in respect of shares in or debentures of another company unless the exchange ... in question is effected for bona fide 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 capital gains tax or corporation tax".

The FTT held in favour of Euromoney that s.137 did not apply on the facts of this case. Whilst the replacement of the £21m cash with shares had been motivated by the avoidance of tax, it had not been a main purpose of the exchange as a whole. In particular, the FTT accepted that:

• The £21m cash was in contrast to the overall consideration of some £85m for the shareholding and the potential tax saving of £2.8m was insignificant in the context of the deal as a whole
• Euromoney was determined to sell its shareholding with or without the tax benefit which was not more than a "nice to have" and not essential
• It was essential that the deal happen smoothly and the tax structuring would only take place to the extent that it did not impede the deal
• Not a great deal of time was spent on the tax analysis (to the extent that it had not been realised that the potential downside of s.137 was that it would prevent the application of s.135 to the whole of the exchange, not just the preference share element, if it applied).

HMRC's appeal was dismissed by the Upper Tribunal (UT). The UT held that the FTT's approach to the question had been correct in considering the exchange as a whole rather than simply focussing on the preference share exchange element. In addition, the FTT's conclusion that the element of the exchange that was tax motivated was not a main purpose of the exchange could not be impeached. The FTT was entitled to conclude that the relatively modest size of the tax advantage viewed in the context of the deal as a whole was relevant. Its conclusion, that this suggested that avoidance of tax was not a "main purpose", was an evaluative conclusion that was open to it.

HMRC appealed to the Court of Appeal.

Decision of the Court of Appeal

The Court of Appeal has now dismissed HMRC's appeal, holding that the FTT and UT had been correct to consider that the question whether there was a main purpose of tax avoidance must be considered by reference to the exchange as a whole, and not simply part of that exchange.

The Court noted that the question was simply one of statutory construction. The provisions of section 137 were clear. It would apply unless:

• the exchange in question is effected for bona fide commercial reasons and
• the exchange does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of tax.

The meaning of the exchange in this context was equally clear -- it meant the exchange as a whole. However, HMRC argued that the "scheme or arrangements" should not have been considered as a whole and that because "exchange" and "scheme or arrangements" had different meanings, it had not been meaningful to suggest that the exchange could not form part of the smaller scheme or arrangements.

The Court, however, rejected HMRC's argument. The plain language of the statue made it clear that the exchange (as a whole) must form part of the scheme or arrangements in order for section 137 to apply. "The "scheme" undoubtedly adds motives and intentions and plans to the "exchange", but the scheme cannot exclude a part of the exchange or a part of the scheme on the natural meaning of the requirement that the exchange "forms part of" the scheme."

The Court also noted that the effect of the statutory language was that "taxpayers can delay paying tax when they exchange shares, but not if the exchange forms part of an entire scheme which has a main purpose of tax avoidance. Put another way, section 137(1) envisages that there may be tax avoidance so long as that is not the sole or a main purpose of the scheme or arrangements. Parliament's purpose is clear from the language it used."

The FTT had been correct to ask the question whether the entire exchange had formed part of a scheme or arrangements of which the main purpose or one of the main purposes was tax avoidance.

Was there avoidance?

Whilst unnecessary to do so, the Court of Appeal also considered the taxpayer's cross-appeal concerning the meaning of avoidance in this context. The taxpayer argued that "avoidance" should be construed objectively as a course of conduct designed to defeat the evident intention of Parliament, as distinct from the acceptance of an offer of freedom from tax which Parliament has deliberately made (a distinction drawn by Lord Nolan in IRC v Willoughby [1997] STC 995). In this context, taking advantage of the SSE was not tax avoidance.

The Court disagreed. Lord Nolan's dictum was not relevant to the construction of section 137, because the regime in sections 135 to 137 provides for the right to defer tax to be lost if it is used to avoid tax. The scheme in this case involved deferring tax in order later to take advantage of the SSE. That was to rely on a provision intended to defer tax to secure an outcome where no tax was paid. The meaning of tax avoidance in section 137(1) is clear without the need to refer to Willoughby. If the scheme or arrangements lead to the non-payment of tax that would otherwise have had to be paid, even if deferred, then that is tax avoidance for these purposes.

Comment

The Court of Appeal's decision represents a robust rejection of HMRC's arguments concerning the application of the anti-avoidance provisions of s.137 in this case. It is the exchange as a whole that must be considered and it is only where that exchange as a whole forms part of a scheme or arrangements to avoid tax that the anti-avoidance provisions are triggered. In particular, the provisions do not prevent tax avoidance which is not a main purpose of the exchange as a whole.

Whilst HMRC did not continue to challenge the factual findings before the Court of Appeal as they had before the UT, the decision also highlights that once the FTT has made findings of fact, it will be difficult for HMRC to persuade the UT to overturn those findings based on arguments around irrationality. In particular, it will be difficult for an appeal to overturn the FTT's findings of fact on the subjective intention of the taxpayer in a tax avoidance or tax advantage scenario. Such findings are heavily dependent on the evaluation of the FTT of witnesses credibility and the UT will reluctant to overturn such findings.