Where the consideration for the disposal of shares or securities consists of shares or securities of the acquiring company, it is often possible (depending on the precise circumstances) to defer recognising any gain for tax purposes until disposal of the new shares.
However, deferral is denied if the ‘exchange’ either:
(a) is not effected for bona fide commercial reasons; or
(b) forms part of a ‘scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to Capital Gains Tax or Corporation Tax’.
Two recent cases, Delinian and Wilkinson, have given helpful guidance on the second leg.
In Delinian Limited ([2023] EWCA Civ 1281) a company sold its shareholding in two joint venture companies for a consideration of about $85m. This was to be some $26m in cash plus ordinary shares in the acquirer. The company later realised that it would be more tax-efficient if it received some of the $26m in redeemable preference shares instead of in cash. On that basis, it would pay no tax when it redeemed the preference shares more than 12 months later (because of the Substantial Shareholdings Exemption (‘SSE’)). So it renegotiated its commercial deal accordingly.
There was no dispute about the fact that the exchange (that is, the exchange of the existing shares for a mix of ordinary and preference shares) was undertaken for bona fide commercial reasons. But HMRC contended that the substitution of preference shares for cash rendered the whole exchange part of a tax avoidance scheme or arrangement.
The key question before the Court of Appeal was whether, in applying the ‘avoidance’ part of the test, it was necessary to look only at the arrangements as a whole or whether it was permissible to look at elements of the ‘scheme or arrangements’ (including the tax-driven substitution of preference shares for cash) separately. Agreeing with the First-tier Tribunal (‘FTT’) and the Upper Tribunal, the Court of Appeal held that ‘the scheme or arrangements that must be considered are the whole of the scheme or arrangements undertaken by the taxpayer in question [their bold], not a selected part or selected parts of them.’
The ‘arrangements’ were characterised by the company (and accepted by the FTT) as being the company’s:
(1) Arm’s length disposal of its shareholdings in [the joint venture companies];
(2) Receipt of (i) the equity holding in [the acquirer], (ii) the preference shares in [the acquirer], and (iii) $4.56 million cash;
(3) Plan to retain its equity holding in [the acquirer] with a view to obtaining the benefit of the projected increase in value; and
(4) Plan to hold the preference shares for over 12 months, until they qualified for [SSE], and then dispose of them for a further $21.2 million cash.
Since the FTT had held, as a matter of fact that had not been challenged, that ‘avoiding tax was one of the purposes of the arrangements as a whole, but was neither a nor the main purpose’ (their bold), it followed that the deferral relief sought was available.
A similar point arose before the FTT in Wilkinson ([2023] UKFTT 695 (TC)). Mr and Mrs Wilkinson owned a controlling interest in a company, which was to be sold in exchange for shares and loan notes in the acquirer. HMRC did not suggest that the exchange was other than for a bona fide commercial purpose. But they considered that it formed part of a scheme or arrangements of which the main purpose, or one of the main purposes, was avoidance of liability to Capital Gains Tax (‘CGT’).
What stuck in HMRC’s craw is best summarised by quoting from the case (for which it is necessary to know that Mr and Mrs Wilkinson had three daughters, none of whom had thitherto been a shareholder in the company):
During the negotiation of the deal, Mr Wilkinson was aware that selling his and Mrs Wilkinson’s shares in P Ltd [Paragon Automotive Ltd] would give rise to a charge to CGT; he was also aware (and this is well illustrated by the “Wishes of the Gift” letter he and Mrs Wilkinson wrote to the daughters on 14 July 2016) that, under certain conditions, the CGT payable by him, Mrs Wilkinson and the daughters (viewed [as] a single economic unit, given the close family ties between them) would be significantly reduced. The conditions were:
(1) that he and Mrs Wilkinson transfer ordinary shares in P Ltd to the daughters, prior to those shares being sold to TF1 Ltd;
(2) that the daughters exchange their P Ltd shares for loan notes or shares of TF1 Ltd, which could be redeemed or sold after a one-year holding period;
(3) that the daughters
(a) receive shares equating to 5% of the ordinary share capital of TF1 Ltd and allowed for 5% of the voting rights in TF1 Ltd; and
(b) be appointed to directorships in trading companies with the P Ltd group; and
(4) that the daughters hold their notes, shares and directorships for one year.
So here, as in Delinian, there were inserted into the transaction steps which, as the FTT agreed, were for the purpose of avoiding a liability to CGT. But, crucially, the ‘scheme or arrangement’ to be considered was the deal as a whole. And as the FTT put it: ‘although the goal of enabling the Wilkinsons’ CGT planning … to proceed, affected the deal in a number of ways, it was not the main purpose, or one of the main purposes, of the deal.’ On the contrary, ‘the pre-eminent “main purpose” of the deal was that the shareholders in P Ltd sell their shares to TF1 for a value of £130 million’.
Both of these cases are therefore welcome clarification of the (limited) scope of the anti-avoidance rule on share exchanges. Essentially, tweaking a commercial deal, or even introducing to it what is manifestly a tax avoidance element, will not necessarily render tax avoidance a main purpose of it.
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