Ardagh Group SA v Pillar [2013] EWCA 900, recently decided by the Court of Appeal, is a distinctly odd case, in which the purchaser of a capital loss company persuaded HMRC to allow the acquired capital losses but then declined to pay the vendor the resulting contingent consideration.
The facts are that the vendor (Ardagh Group SA) owned a UK resident subsidiary, Yeoman, which had realised capital losses of £112m but no capacity to use them. In 2001, Ardagh sold Yeoman to Pillar, whose UK group had capacity. Pillar agreed to pay £2.2m upfront and contingent consideration of 9% of the losses used.
Didn’t the pre-entry loss rules spoil the party?
The ‘pre-entry loss’ rules precluded Yeoman’s losses being used within the purchaser’s group, unless they were disapplied by FA 2000 Sch 29 para 7(9). FA 2000 brought non-resident companies (such as the vendor) within the definition of a chargeable gains group. This caused singleton UK companies (such as Yeoman) with a non-resident parent to ‘enter’ a group. It was not the policy intention that this technical grouping should trigger the pre-entry loss rules and, accordingly, FA 2000 provided that they should not apply to any existing losses of a UK company affected by the technical grouping. Literally construed, the FA 2000 restriction applied not just to the technical grouping but to all subsequent ‘real’ changes of ownership of a loss company (such as the purchase of Yeoman by Pillar). This was, however, unlikely to have been the policy intention.
How did Yeoman’s losses come to be used?
Pillar group companies elected under TCGA 1992 s 171A to transfer capital gains to Yeoman, which claimed to offset its losses against them. The claims were refused by HMRC on the grounds that the FA 2000 restriction on the pre-entry loss rules did not apply to the subsequent sale of a loss company to an entirely different group. This remained HMRC’s position ever after.
Yeoman’s appeal was considered by HMRC alongside other tax disputes within the purchaser’s group. All outstanding issues were compromised in 2009 by a bizarre contract settlement, under which HMRC allowed £82m of Yeoman’s losses against other group gains (despite maintaining the offset was legally invalid) and a different group company relinquished potentially valid tax claims of equivalent value. It seems the purchaser’s group may have wanted effect to be given to Yeoman’s losses, rather than the other group company’s, as this resulted in a saving of interest on late paid tax.
How was the claim for contingent consideration resolved?
Ardagh claimed £7.39m contingent consideration from Pillar (9% of the losses). Pillar refused to pay on the grounds that Yeoman’s losses were not allowable in law and, even if HMRC had technically allowed them, they had produced no commercial net benefit. Ardagh appealed on the grounds that, upon its true construction, the sale contract was solely concerned with whether the losses had been used and contained no requirement, even by implication, that their use should produce any commercial net benefit. The Court of Appeal agreed.
Was the ‘package deal’ lawful and what about the LSS?
Perhaps unsurprisingly, neither party wished the court to determine the legality of the package deal. HMRC’s litigation and settlement strategy (LSS) was in force, but the judgment does not discuss whether the package deal complied with it. HMRC sharpened the LSS in 2011 to ban package deals. Even if the contract settlement complied with the original LSS, it is astonishing that HMRC allowed a loss offset which it steadfastly maintained was invalid, especially if (which is not clear) it knew this would result in an interest saving.
In this sense, the case is reminiscent of the challenge by UK Uncut of HMRC’s decision to settle a NICs dispute with Goldman Sachs without charging interest (UK Uncut Legal Action v HMRC [2013] EWHC 1283 (Admin)). Their claim that this was unlawful for failing to follow the LSS was unsuccessful, but put an intense spotlight on a string of legal and procedural errors by HMRC officials.
What are the lessons for advisers?
From the litigation standpoint, this is surely a ‘limited edition’ case. HMRC has had a torrid year, in which it has been accused in Parliament of being soft on tax-avoiding big companies and suffered the indignity of the UK Uncut judicial review. It seems inconceivable that it would ever again enter into a package deal of the kind seen in Ardagh. Nevertheless, HMRC’s unresolved caseload is at a record high and it is under pressure to clear the backlog. So you never know.
There are, however, valuable lessons for the drafter of contingent consideration provisions. The case shows that losses can be allowable, or even allowed, with no commercial net benefit to the purchaser. The drafter will, therefore, rarely provide for a percentage of a loss to be payable on the loss becoming available, as it may end up stranded in the wrong company. It should also beware providing for such consideration to be payable on the loss being used, as its use may oust an otherwise available purchaser relief or the rate of tax may fall. Even providing for contingent consideration to be payable on tax actually saved can be risky, because, as Ardagh demonstrates, HMRC may allow a legally invalid tax saving. To deal with these hazards (however unlikely one may now be), the drafter could limit the payout by reference to the commercial net benefit produced by the losses. Quantifying that benefit will really test his drafting skills.
