In a reverse of an Upper Tribunal decision, directors required to give warranties on the sale of their shares can adjust their capital gains tax charge for contingent liabilities. HMRC publishes preliminary guidance on the new loan relationships rules for corporate rescues and substantial modifications to debt terms. The Upper Tribunal gets lost in the labyrinth of the stamp duty land tax ‘anti-avoidance’ rules, which can, surprisingly, apply regardless of any purpose to avoid tax. Finally, there is some (but not too much) simplification of the tax rules for partnerships.
The Scottish Court of Session (CS) has decided that a payment made to settle an action for misrepresentation by an individual on the sale of a company, of which he was both chairman and shareholder, can give rise to an adjustment to his capital gains tax (CGT) charge.
In Sir Fraser Morrison v HMRC [2014] CSIH 113, the taxpayer was a major shareholder, chairman and chief executive of a supermarket company. A third party made an offer to purchase the shares of the company. Information was provided by the taxpayer, in his capacity as chairman, as to the state of the business; this included a profit forecast that turned out to be materially inaccurate. The purchaser sued the taxpayer for making false representations and misstatements. The case was subsequently settled by a payment of £12m by the taxpayer, but without any admission of liability on his part.
The taxpayer sought to reduce his CGT charge by £12m. This was on the basis of rules providing for an adjustment where a contingent liability is subsequently enforced in respect of a warranty or representation made on a sale of property (TCGA 1992 s 49).
Although the First-tier Tribunal had agreed with the taxpayer, the Upper Tribunal did not. This was because the liability under the settlement was not directly related to the value of the consideration received for the shares. The taxpayer’s liability arose because of representations made by him with his chairman’s hat on, and was wholly distinct from the consideration he received as owner of the shares.
The CS held that at the time the representation was made, the taxpayer had incurred a contingent liability. However, the capacity in which he made the representation should make no difference (as there was no reference to this in s 49(1)(c)). The basis on which the contingent liability arose was that he had made representations which induced the purchaser to buy the shares, including his own; the representation could then properly be described as having been made on the sale of the shares. The statutory requirements were met. This conclusion reflected the reality that, after settling the claim, the gain realised was reduced by £12m (although the court remitted the extent of the adjustment).
This decision will come as some relief to selling shareholders who are also directors making representations or warranties as part of a share sale. The capacity in which the representations are made is irrelevant. However, there may be a chink of light remaining for HMRC. Rather oddly, counsel for HMRC conceded that the contingent liability had been enforced in this case, even though the taxpayer had not accepted liability as part of the agreed settlement. Some doubt must therefore remain as to whether a settlement where liability is not accepted means that the liability is enforced, so as to be squarely within the terms of the statute.
As part of the reform of the loan relationships rules, the pre-election Finance Bill (FB 2015) is expected to introduce new tax reliefs for corporate rescues and substantial modifications to borrowing terms that might otherwise give rise to a tax charge. Draft legislation was published on 10 December, and HMRC has now published provisional guidance.
A release of debt between unconnected parties can result in a tax charge for the borrower. However, existing exemptions are available for distressed debt where there is a release in insolvency, or a debt-for-equity swap. A new exemption will apply for debt releases as part of a corporate rescue. For the relief to apply, it must be reasonable to assume that, but for the release and related arrangements, there would be a material risk that the company would be unable to pay its debts sometime within the next 12 months.
Under new UK GAAP and IFRS, a significant amendment of debt (say, to the interest rate or the term, in a modification often called an ‘amend and extend’ exercise) can result in accounting credits or debits for which the borrower can be taxed. The new legislation and related regulations will exempt any credit or debit arising from a substantial modification, subject to it satisfying the same conditions for the new corporate rescue exemption.
In its provisional guidance, HMRC says that the corporate rescue exemption is aimed at companies in significant financial distress; and it applies in addition to, or instead of, the existing exemption for debt-for-equity swaps. It is not, HMRC confirms, necessary to look at the release in isolation, so other negotiations and actions can be taken into account when deciding whether the company would otherwise be unable to pay its debts within the next 12 months. The guidance is also helpful in demonstrating that the tax tests are different to those for wrongful trading. Therefore, the use of the exemption should not imply that directors are in breach of their company law obligations by continuing to trade. Since the significant modification exemption uses similar concepts, the same guidance will also apply here.
Although these changes are to have effect from 1 January 2015, they will not be enacted until FB 2015 becomes law. The (albeit low) risk is that companies could therefore be relying on reliefs that are not ultimately introduced.
In Project Blue Ltd v HMRC [2014] UKUT 0564 (TCC), the Upper Tribunal (UT) applied the labyrinthine ‘anti-avoidance’ rule for SDLT.
In 2007, following some fairly prolific SDLT avoidance, a wide spectrum antidote (at FA 2003 ss 75A–75C) was introduced. Under the heading of ‘anti-avoidance’, the sections apply formulaic tests to see whether ‘scheme transactions’ should be taxed on the basis of an alternative ‘notional transaction’, which generates a higher SDLT charge.
The case concerned the sale by the government of Chelsea Barracks to Project Blue Ltd (PBL) for £959m in 2008. PBL entered into a Sharia compliant financing, comprising a sub-sale of the property to its financing bank (MAR) for £1.25bn. MAR then leased the property back to PBL, with put and call options, to enable the freehold to revert to PBL at the end of the financing.
Under the rules for sub-sales in place at the time, the initial sale of the land to PBL was disregarded (FA 2003 s 45). The purchase by MAR, the leaseback to PBL and the options were all exempt from SDLT under special rules for alternative property finance (FA 2003 s 71A). As a result, no SDLT was payable on the transactions, which the UT acknowledged was due to a flaw in the legislation, unless they could be brought within the ‘anti-avoidance’ rule. The First-tier Tribunal held that they could, so PBL was liable for SDLT on £1.25bn.
The UT expressed some discomfort at being asked to apply the rules, at least when they are described as anti-avoidance, in order to cure a defect in the interaction of the sub-sales and alternative finance provisions. In a finding that highlights the perhaps unique status of the SDLT anti-avoidance rules, the UT held that there was no requirement for an anti-avoidance purpose. This was despite the heading of the sections; the use of language such as ‘scheme’ transactions; and the list of examples that might lend themselves to use or misuse for tax avoidance purposes. Instead, the rules spell out what is meant by a case of ‘avoidance’. If the transactions meet this statutory description, SDLT can be charged on the alternative notional transaction. The UT could not read into the rules a purpose test, as it was not possible to discern what form this would take in an SDLT context.
Exactly how the rules should be applied to the facts then led to some differences between the UT judges. Mr Justice Morgan, as the lead judge, admitted that their application to the relatively simple facts of the case was high up the scale of difficulty, and confessed to an instinctive reaction that SDLT was payable by PBL on £959m. However, when looking at the detail of the provisions, he held that it was possible that SDLT could be payable by MAR on £1.25bn. As MAR was not a party to the proceedings, the lead judge fell back on his instincts (with some help by way of further written submissions from counsel).
Judge Nowlan concluded that PBL was liable for SDLT as lessee under the leaseback on £1.25bn. He held that the purpose of the SDLT rules, looked at more broadly, was for the purchaser of a land interest, not the financing bank, to pay SDLT. The lead judgment prevailed, however.
There is a lesson here for HMRC and the government. They are devising ever more fiendish anti-avoidance rules, which in this case do not even require a purpose of avoiding tax. If the statutory rules prove almost impossible for the senior members of the judiciary to apply to fairly simple fact patterns, there is something wrong with those rules. This is also perhaps a foreshadowing of how the judiciary might react when they eventually have to tackle the general anti-abuse rule.
The lack of black letter tax law on partnerships makes it an esoteric area of practice, with longstanding guidance from HMRC to fill in the blanks. The Office of Tax Simplification (OTS) has published its Review of partnerships: final report, with little appetite, at least from HMRC, for wholesale changes.
The areas highlighted as giving rise to particular uncertainty include international partnerships, where it is recommended that partnerships be fully recognised in double tax treaties; and HMRC’s treaty passport scheme, which the OTS believes should be extended beyond corporates. Clearer guidance is also required on limited liability partnerships and group relief.
Many will breathe a sigh of relief that there is no appetite for legislating the much pondered SP D12 on capital gains tax and partnerships, which has certainly stood the test of time, although some might question how well it is actually understood. HMRC has agreed, however, to modernise some of the terminology and to include additional guidance on more difficult areas in the partnership manual.
The closing date for comments on draft FB 2015 was 4 February and the deadline for commenting on hybrid mismatches was 11 February. There is still time to comment on the withholding tax exemption for private placements by 27 February.
