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Tax disputes expert Steven Porter of Pinsent Masons said: “The court has provided welcome confirmation that when considering the share for share exchange anti-avoidance provisions, it is necessary to look at the whole scheme or arrangement undertaking by the taxpayer, not selected parts of it”.
“The court has also given guidance on the meaning of tax avoidance in this context: a scheme that leads to non-payment of tax that would otherwise have to be paid, even if it would have otherwise been deferred, is tax avoidance,” he said.
Delinian Limited – known as Euromoney Institutional Investor PLC in the earlier hearings of this dispute – had negotiated terms with a third-party buyer to buy its shares in two joint venture companies.
The original terms of the deal involved some of the consideration being in cash and some an exchange of shares. However, before the deal was finalised, Delinian’s tax director identified that the sale of one of the classes of shares for cash – preference shares with no dividend rights – would not qualify for exemption from tax under the substantial shareholdings exemption (SSE). Delinian therefore requested an adjustment to the sale structure so that the cash element of the consideration was replaced with an exchange for redeemable preference shares.
Under the revised sale structure, the exchange of the shares for redeemable preference shares would be treated as a rollover for capital gains purposes and, once the preference shares had been held for at least 12 months, the subsequent redemption for cash would qualify for SSE. The buyer agreed to restructure the transaction.
Delinian applied to HM Revenue & Customs (HMRC) for clearance that the transaction would be treated as a share for share exchange, but the transaction completed before HMRC replied. When HMRC did reply, it refused clearance.
HMRC subsequently enquired into Delinian’s tax return and issued a closure notice treating the entire transaction, not just the preference share element, as a taxable disposal. It did so because it considered that an anti-avoidance provision was triggered which applied to arrangements with a tax avoidance main purpose. Delinian appealed and the matter was considered by both the first-tier tax tribunal (FTT) and the Upper Tribunal (UT). The FTT and the UT found in Delinian’s favour, finding that the “arrangements” in question were the whole arrangements of which the exchange formed part and not just one element of those arrangements. Though the FTT and UT considered that there was a tax avoidance purpose to those arrangements, they determined that was not a “main purpose” of the transaction.
Section 137(1) of the TCGA 1992 prevents a deferral of tax on a share for share exchange “unless the exchange … in question is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is [tax] avoidance”.
Jake Landman, tax expert at Pinsent Masons, said: “It was common ground that the exchange of preference shares had been effected for bona fide commercial reasons. However, the court did still make some observations on this limb of the test that may be helpful to taxpayers in applying this provision to their corporate transactions. In particular, the court commented that ‘it cannot be controversial to comment that one can enter into a share exchange transaction for bona fide commercial reasons even if that transaction is wholly or partly tax driven’.”
HMRC’s challenge centred only on the identification of the “scheme or arrangement”. It argued that there were many possible schemes or arrangements and that the question was how to identify the right one in order to determine whether it had a tax avoidance purpose. HMRC argued that it was at least possible that the exchange of shares in question could be part of a smaller scheme, i.e. that the decision to change the consideration from cash to redeemable preference shares was the scheme in question and that this scheme had a tax avoidance purpose.
The Court of Appeal did not accept HMRC’s position, finding that the natural use of the language in the statute is to ask whether the entire exchange forms part of a whole scheme which has a main purpose of tax avoidance. It is not possible for the scheme in question to exclude part of the exchange. The Court of Appeal found that the statutory language asks “whether the entire exchange agreed did or did not form part of an entire scheme or arrangements of which the, or a, main purpose was tax avoidance”.
Delinian had also raised a ground in its respondent’s notice regarding the meaning of the word “avoidance”. It argued that avoidance required a course of conduct “designed to defeat the evident intention of Parliament” and that this should be contrasted with what Delinian did, which was to accept an “offer of freedom from tax which Parliament has deliberately made” i.e. to use the deferral mechanism and the SSE. The Court of Appeal rejected this contention because looking at the tax deferred it was later avoided by use of the SSE. Specifically, the Court commented “Euromoney’s scheme or arrangements involved deferring tax in order later to take advantage of the substantial shareholdings exemption.”
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