Question: Our client (Company A) previously acquired a joint venture business (JVCo) with a third party company (Company B). Company B purchased a 40% equity stake (with equivalent voting rights) in JVCo, and a detailed investment agreement was drawn up wherein the rights of Company A and Company B were set out. Company B subsequently made a £1m loan to JVCo to fund its business activities. JVCo is now seeking to repay the loan at a discount – should the credit to the P&L arising from the release be taxable in JVCo?
Answer: The key question is whether the release should fall within the provisions of CTA 2009 s 358 which states that if a debt release takes place in an accounting period for which an amortised cost basis of accounting is used and the relationship is one between connected companies, the credit should only be brought into account if there is a ‘deemed release’, or release of ‘relevant rights’. We understand that JVCo uses an amortised cost basis, and that the transaction is not a ‘deemed release’/release of ‘relevant rights’ as the creditor relationship was not acquired in circumstances where a charge under CTA 2009 s 361 was avoided. Therefore, to avoid a taxable release, it suffices to demonstrate that the relationship is a connected companies relationship. Connection for the purpose of s 358 is defined in CTA 2009 s 466 as the circumstance whereby one company has control of the other, or both companies are under the control of the same person. ‘Control’ is defined in CTA 2009 s 472 as the ‘power of a person to secure that the affairs of the company are conducted in accordance with the person's wishes:
There are a number of factors here which need to be assessed conjunctively and weighted accordingly. Often in practice, the first bullet above is awarded more weight, however, case law suggests otherwise: ‘Nobody doubts that control of the company’s affairs may be obtained by means [of shareholding] but the case does not in any way demonstrate that this is the only means possible’ (Walton J, Irving v Tesco Stores (Holdings) [1982] 58TC1). In your client’s scenario, Company B does not control JVCo when considering only voting rights/shareholding. However, in this case it is also important to consider in detail the other documents that are available, being the investment agreement and the Articles of Association. Our review of these demonstrates that Company B has significant powers conferred to it, as summarised below.
Day-to-day affairs: The investment agreement discloses a set of conditions to which JVCo, Company A and Company B must adhere. These are numerous and wide-ranging and effectively give Company B power to control the day-to-day business activities of JVCo. For example, JVCo may not, without consent, issue staff bonuses, initiate legal proceedings or ‘make any material change in the nature or scope of the company’s business.’ In the case of Fenlo v Revenue and Customs Commissioners [2008] STC (SCD) 1245 it was held that restrictive covenants did not amount to control on the basis that they were: ‘restricted in their scope and negative in nature ... The facility letter did not have flavour of, nor was akin to, articles of association of a company’. In your client’s case, the tone of the investment agreement is markedly different, and it clearly sets out to override the Articles of Association in all material respects. The most powerful of the conditions prevents Company A from making any significant decisions about the business without Company B’s consent. Whilst Company A currently have a majority of directors, this is of limited effect if decisions reached by them are required to have Company B approval. Furthermore, Company B consent is required for ‘everyday’ tasks (eg, issuing bonuses). Under normal circumstances it would be reasonable to expect JVCo management to be able to carry out such tasks independently in the course of their ordinary duties. The fact that Company B consent is required for even basic activities gives further weight to the view that Company B has control over JVCo.
Directors: Per the investment agreement, Company B may appoint one person to the JVCo board. The Articles stipulate that there shall be at least two directors, giving rise to a potential situation whereby Company A and Company B are equally represented on the board. Company B may remove its director and appoint a replacement for any reason, whereas Company A is only permitted to take the same action with Company B consent. Whilst it is true that Company A could remove director(s) by ordinary resolution, by virtue of its majority voting rights, in practice the Investment Agreement prevents this. This arises from a provision which states that Company A cannot ‘make any material change in the nature or scope of the company’s [JVCo’s] business’, which in our view could also extend to the removal of director(s). Whilst this conflicts with the Articles, it is made clear in the Investment Agreement that ‘if the provisions of the articles ... conflict with the provisions of this Agreement then... the provisions of this Agreement shall prevail’. It therefore follows that JVCo may be unable to appoint/remove directors without Company B consent.
Having analysed the pertinent facts/documentation in your client’s case, on balance, we consider that Company B has the power to conduct the affairs of JVCo in accordance with its wishes, and therefore the companies are connected for the purposes of CTA 2009 s 358. However, this is clearly not free from doubt, evidenced by the fact that the control concept has frequently been tested in the courts. On this basis, we would strongly recommend that for the avoidance of doubt, your client applies to HMRC for non-statutory clearance (note that there is general requirement in applying for non-statutory clearance on direct tax issues for the issue to be commercially significant to the company and this should be justified in the application).
Praveen Gupta, Tax Director, BDO
Email: praveen.gupta@bdo.co.uk
Tel: 0121 3526253
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