Tax planning in a transactional context: First-tier Tax Tribunal decision shows importance of commercial context

The last twenty years have seen a sea change in both public attitudes to tax avoidance and, as reflected in the addition of TAARs (statutory targeted anti-avoidance rules) and the introduction in 2013 of the GAAR (General Anti Abuse Rule), the treatment of tax avoidance in UK legislation. In the 1990s or early 2000s, structures designed to obtain a tax benefit which did not reflect commercial reality (e.g. the creation of a tax loss when there was no commercial loss or obtaining tax relief for dividend payments) might have been effective. However, today generally for tax structuring to be effective and, from a reputational perspective, acceptable, it must fit into, and accord with, the commercial reality.

As noted in the recent M Group Holdings Limited case, the UK tax regime has no doctrine of “economic equivalence”. There is no overarching UK tax rule linking the incidence of tax to the underlying economic position of the taxpayer. However, the days of tax-led financial structuring in which the prospective tax benefits determined the commercial course of action (as opposed to how a proposed commercial course of action might be undertaken) are over.

The relevance and importance of the commercial context is demonstrated in the recent Wilkinson case, as explained by our tax solicitor Michael Fluss in this article.

Facts of O Wilkinson and others v HMRC

An example of how tax structuring might be effective in the reality of today’s world is evident from the decision of the First-tier Tax Tribunal in the Wilkinson case. In very broad terms, in that case:

• The (58%) majority shareholders in the prospective target company (“T Ltd”), Mr and Mrs Wilkinson, gifted some of their shares in T Ltd to their daughters and claimed the applicable holdover relief from CGT, so that, instead of the parents realising a deemed capital gain on the gift, the daughters inherited their parents’ base cost in those shares.
• A few days later the entire issued share capital of T Ltd was sold to a third party for £130m for a combination of cash and shares and loan notes in the acquiror, with the daughters:
• receiving loan notes redeemable after 12 months and 5% shareholdings in the acquiring entity; and
• being appointed to (non-executive) directorships in trading companies in T Ltd’s group.

Purpose of steps

The purpose of the above steps in so far as they related to the daughters was to ensure that, on redemption of the loan notes and the sale (on or after redemption) of their shares, the daughters would benefit from entrepreneurs’ relief and so be taxable at 10% on the gain arising on the redemption and sale. Mr and Mrs Wilkinson and their daughters (viewed as a single economic unit, given the close family ties between them) would therefore pay less CGT in total than Mr and Mrs Wilkinson would have paid in total had  those steps not been implemented. It was considered that, by virtue of the “paper for paper” capital gains rollover relief rules, no gain should arise to the daughters on the sale to the third party of their shares in T Ltd until such time as the consideration shares and loan notes were sold or redeemed. At that point, the daughters would, by virtue of those rules, have been treated as having held their shares in T Ltd for the requisite period for the purposes of entrepreneurs’ relief. Or so it was thought.

HMRC’s approach and decision of First-tier Tax Tribunal

HMRC, however, considered the above CGT planning fell foul of the longstanding anti-avoidance provisions in those rollover relief rules, which preclude the relief where the “paper for paper” exchange is not effected for bona fide commercial reasons or forms part of a scheme or arrangements of which the main purpose, or one of the main purposes, is the avoidance of liability to CGT.

HMRC therefore sought to assess the daughters to CGT on the sale of their shares to the third party as if those rules did not apply, with the result that entrepreneurs’ relief (now, the more limited business asset disposal relief) would not be available to the daughters (who had not, at the time of that sale, held their shares for the requisite amount of time for the relief to be available and so would have been liable to CGT at 20%).

The judge in the case disagreed, in essence because the main, “pre-eminent”, purpose of the deal was the sale of all the shares for £130m, not the CGT planning (which, though a purpose, was not the main purpose of the sale). In particular, the judge noted that:

• the large minority shareholding bloc – those who held approximately 42% of T Ltd’s ordinary shares – had no stake in the Wilkinsons’ CGT planning;
• even for the Wilkinsons, as the majority shareholders, viewed in isolation, the value of the CGT planning – about £3 million – was small: about 4% of their approximately £73 million (anticipated) proceeds;
• under the heads of terms, the buyer could effectively “walk away” if it was not “comfortable” with the sellers’ proposed tax planning in terms of its commercial effects – the heads of terms did not require the Wilkinson’s CGT planning to be adopted;
• as shown in email correspondence, Mr Wilkinson was not prepared to scupper the deal even if the structuring required for Wilkinsons’ CGT planning could not be achieved; and
• the sale and purchase agreement gave no protection or price adjustment if the Wilkinsons’ CGT planning did not have the desired effect.

Significance of case

The Wilkinson’s CGT tax planning was largely (even though not entirely) “built into” the commercial deal. That, it would seem, helped ensure its efficacy. The case highlights that, in general, for tax planning in a transactional context to be effective (and indeed acceptable), sound commercial drivers in relation to the course of action chosen must be present. Steps aimed at enhancing the taxpayer’s position should be largely subordinate to, not interfere in any material way with, and work substantially within, the framework of the commercial objectives of the parties.

It is, of course, possible that the case will be appealed by HMRC. However, the judge’s decision was robust yet nuanced and well-reasoned, and should therefore serve as a source of useful guidance for tax professionals advising on paper for paper/share for share exchanges.

If you have any questions on CGT planning and the reorganisation rules, please contact Michael Fluss.