Restriction on tax free intra-group transfers contrary to EU law?

The Upper Tribunal has referred to the ECJ questions concerning the failure of the UK to extend "no gain no loss" rules to transfers of capital assets to group entities resident in Member States of the EU and in Switzerland: Gallaher Ltd v HMRC [2020] UKUT 354. Given the decision of the Upper Tribunal was only handed down on 14 December 2020, the case may well be one of the last in which the courts refer matters to the ECJ in a tax context.

The case concerns the controversial argument that the ECJ case law requiring deferral of tax (such as in the exit cases involving unrealised gains) can be extended to gains which are in contrast realised (and therefore in circumstances where the taxpayer in principle has the funds to pay the tax).

Background

The case concerned a reorganisation of a Japanese headed multinational group. The taxpayer was a UK member of that group. In 2011, the taxpayer sold certain IP rights to a Swiss member of the group (SwissCo) and in 2014 the taxpayer sold all of its shares in a subsidiary to another Dutch member of the group (DutchCo). Both disposals gave rise to chargeable gains. It was accepted that there was no question of tax avoidance on the facts.

The taxpayer contended that the UK rules were contrary to EU law. In particular, it contended that the fact that the no gain no loss provisions in TCGA 1992 s.171 (and equivalent provisions applying to intangible assets) were limited to transfers of assets to companies within the UK tax net (either UK resident or with a UK PE to which the assets related) was contrary to the freedom of establishment and free movement of capital. More specifically, the taxpayer argued that the deficiency in the no gain no loss rules was the failure to allow a deferral of the corporation tax liability in this situation, as had been recognised by the European Court of Justice (ECJ) in various "exit charge" cases.

The FTT held that whilst the transfer of IP assets to the Swiss group company was not protected by the fundamental freedoms, the transfer of shares to the Dutch group company was and that the failure to allow any form of deferral of the gains arising on that transfer could not be justified. Both Gallaher and HMRC appealed to the Upper Tribunal.

Decision of the FTT

The FTT decided that the relevant freedom to consider in these cases was the freedom of establishment and not the free movement of capital. The circumstances of this case involved wholly owned subsidiaries and clearly fell with the concept of "direct influence". The case law of the ECJ made it clear that company's in such a situation are exercising their freedom of establishment. Moreover, legislation aimed at relations within a group of companies primarily affects the freedom of establishment and any effects on the free movement of capital should be regarded as simply "unavoidable consequences".

That was sufficient to deal with the 2011 transfer of IP to SwissCo. It was only if the taxpayer could rely on the free movement of capital (which applies to third country situations, unlike the freedom of establishment) that it might call into question the legality of the UK rules in relation to its transfer to SwissCo.

As regards the transfer of shares to DutchCo, the FTT held that the UK rules, in failing to extend the no gain no loss rules to a transfer to an EU subsidiary within the group structure represented a restriction on the freedom of establishment. The tax charge would not have arisen if the transfer had been to another UK subsidiary. Could the imposition of the charge be justified in these circumstances nevertheless? In particular, was it simply a case of securing a "balanced allocation of the taxing rights" in relation to the shares between the UK and the Netherlands? The FTT agreed that the rules did simply seek to allocate the right to tax gains between the UK and the Netherlands, but they must also be proportionate to satisfy the EU rules.

By analogy with earlier ECJ decisions that an upfront tax charge could be disproportionate in the "exit charge" cases, the FTT held that the failure of the UK rules to allow any deferral was disproportionate. The FTT rejected HMRC's argument that the "exit charge" cases were not relevant as they dealt with situations where there was a deemed disposal of assets on the migration of a person or company and so the gains in those cases were "unrealised". The reason the deferral was needed in those situations was that it was disproportionate to require upfront taxation of the gain on the assets where the taxpayer was not actually disposing of them and would not have the funds to pay the tax. In the current case, the taxpayer had actually sold the shares and so the same cashflow problems were not relevant.

Having decided that the UK rules were contrary to EU law, the FTT concluded that it was not able to apply a "conforming interpretation" to the UK tax rules so as to introduce a provision for deferral. Instead it was necessary to disapply the offending UK rule. That was to be achieved by disapplying the provision in s.171 which limited it to transfers to a transferee within the UK tax net. The FTT recognised that this meant that the accrued gain would fall outside the scope of UK tax entirely.

Decision of the Upper Tribunal

Before the Upper Tribunal it was accepted that the UK rules did represent a restriction on the freedom of establishment, but HMRC continued to argue that the UK rules could be justified by the need to provide for a balanced allocation of taxing rights. In contrast, the taxpayer continued to argue that the free movement of capital was also relevant and that the caselaw of the ECJ showed that the UK was required to provide a deferral mechanism.

The Upper Tribunal has decided to refer to the ECJ essentially all of the substantive issues raised before the FTT. Despite the existence of a substantial body of case law relating to broadly analogous situations, there was no direct authority dealing directly with tax neutral treatment of intragroup transfers of assets in cases where the taxpayer company has realised a full market value consideration for the transfer.

These matters referred to the ECJ included:

• Questions concerning whether the freedom of establishment was the only freedom relevant in the circumstances or whether the free movement of capital could also be relied on.
• Questions concerning whether the UK was obliged in the circumstances to provide some form of deferral mechanism, despite the gains being realised gains, to ensure that the legislation was proportional.
• If so, whether deferral based on payment in instalments over five years would be appropriate or whether deferral until later realisation would be necessary.

However, the parties (and the Upper Tribunal) all agreed that the FTT had been wrong to concluded that, if a conforming interpretation were not possible, then the correct approach was to disapply the relevant provision. The FTT treated disapplication as involving a striking out of words or provisions in domestic legislation (with the result that no tax liability would arise). The correct approach was that disapplication required the relevant domestic legislation be read as applying without prejudice to directly enforceable EU law rights.

Comment

The decision of the FTT that the UK should be obliged to defer the tax payable on an actual disposal of shares where the taxpayer has the funds to pay the tax was controversial. On this point, it should be noted that the disposal was required to be brought in at market value as it was a transaction between related parties, and this may have a bearing on whether failure to allow deferral is disproportionate. It is far easier to see why rules taxing unrealised gains should benefit from deferral in a migration situation than in an intra-group transfer. Particularly as all parties recognised that the UK had the right in this case to tax the accrued gain on the shares.

Following the FTT decision, the government introduced legislation in Finance Act 2020 to permit UK resident companies to enter into payment plans and to pay tax by instalments in relation to intra-group transfers of assets to companies resident in EEA member states. They apply to all accounting periods ending on or after 10 October 2018. Of course, this is an area of "retained EU law" as defined in the 2018 Withdrawal Act which the government could, in principle, choose to revisit following the end of the transition period.