Main purpose of obtaining a tax advantage and the case for seeking HMRC clearance and contemporaneous tax advice
Background
Share for share exchanges are regularly seen in various types of company sale and reorganisation transactions.
Broadly, where a shareholder exchanges shares in Company A for shares in B, and following on from this exchange Company B Holds more than 25% of the shares in Company A, it is deemed that there is no disposal of the shares in Company A. Rather, the shares in Company B ‘stand in the shoes of’ Company A (i.e. they are treated as having been acquired at the same time and for the same consideration as the shares in Company A). Since there is no disposal for tax purposes, there is no gain or associated tax liability.
This ‘tax free rollover’ treatment is subject to various conditions, including that the transaction is undertaken for bona fide commercial reasons and is not part of a scheme or arrangement of which the main purpose, or one of the main purposes, is the avoidance of liability to capital gains tax or corporation tax (the ‘main purpose’ test).
HMRC provides a statutory clearance service whereby they will confirm in advance of a transaction that the main purpose test is met so that the share exchange can be treated as tax free (if the other technical conditions are satisfied). When tax advisors talk about ‘obtaining HMRC clearance’ for a transaction, this is more often than not what they are referring to.
Euromoney case
Euromoney agreed to sell its shares in a subsidiary to another company. As consideration for the disposal, Euromoney was to receive a mixture of cash and shares in the purchaser. Euromoney would have paid corporation tax on the cash element of the consideration because the conditions for the Substantial Shareholdings Exemption were not met at that time.
After this deal was agreed, the tax director of Euromoney’s parent company suggested that the deal could be restructured such that Preference Shares were received instead of cash. The intention was that the gain on the sale of the Euromoney shares in exchange for Ordinary and Preference Shares in the purchaser would qualify as a tax free rollover and the Preference Shares would be redeemed at a later date when the conditions for the Substantial Shareholdings Exemption were satisfied to exempt the gain.
This deal was agreed with the purchaser and the sale went ahead.
After the transaction, Euromoney applied for clearance from HMRC that the transaction had been undertaken for bona fide commercial reasons and did not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, was the avoidance of liability to capital gains tax or corporation tax. Presumably Euromoney believed that only the Preference Share element of the transaction was vulnerable to HMRC challenge and therefore there was no downside to replacing the cash consideration with Preference Shares. However, HMRC argued that the entire transaction fell foul of the main purpose test and the gain in respect of the total consideration (Ordinary and Preference Shares) was subject to corporation tax.
Nevertheless, Euromoney chose to report the transaction in its corporation tax returns as if the tax free share exchange rules applied. HMRC enquired into the corporation tax returns and subsequently issued an assessment for the additional tax that they considered was due.
Euromoney took the case to the First Tier Tribunal (“FTT”), which found in their favour. The Upper Tribunal (“UT”) subsequently dismissed HMRC’s appeal. Now, HMRC’s appeal to the Court of Appeal (“CoA”) has been dismissed and it remains to be seen whether it will make a final appeal to the Supreme Court.
Key points of the CoA decision were that –
- A transaction can be undertaken for bona fide commercial reasons and still form part of a scheme or arrangements for the avoidance of tax (i.e. the main purpose test is a two limb test);
- In determining whether a scheme or arrangement has a main purpose of obtaining a tax advantage, it is necessary that this is considered in terms of the whole of the scheme or arrangements and not just a part of them; and
- The legislation permits tax avoidance being a purpose of arrangements, provided that it is not the main purpose.
The case for tax clearances and contemporaneous tax advice
Whilst the case raises many extremely interesting points (for those so inclined!) around how the main purpose test operates, it also brings to the fore the advantages of seeking HMRC clearance and contemporaneous tax advice more generally.
Statutory tax clearances are not compulsory, however, where there is any element of doubt as to whether the main purpose test is satisfied, we recommend that pre-transaction clearance is sought and that this should be factored into the transaction timetable. Generally, HMRC have 30 days to provide a response to a statutory clearance application, but if this response is to ask further queries of the taxpayer in relation to the transaction then the 30 day clock is reset. Seeking clearance allows the taxpayer certainty ahead of implementing the transaction to give them peace of mind. Where the transaction timeline does not allow for clearance to be sought, a defence paper should be prepared to document the risks, if any, and any relevant mitigating factors.
Transactions can unfold at speed and potential commercial and tax saving opportunities may emerge along the way as they did in the case of Euromoney. Euromoney had not taken independent tax advice on the potential adverse implications of the change to the consideration structure before proceeding with the transaction. Clearly, our recommendation is that tax advice is obtained at an early stage of any deal process and that tax advisors are made aware of any changes as the deal proceeds.
Clients will sometimes ask whether seeking clearance weakens their position by bringing HMRC’s attention to perceived ‘vulnerabilities’ in the fact pattern of a transaction. In our experience, choosing not to apply for and wait for a clearance as a demonstration that tax avoidance is not a main purpose can backfire badly. Further, a taxpayer is well within their rights to disagree with HMRC’s view given in response to a clearance application. Whether or not HMRC grant clearance, we recommend that full disclosure of the filing basis is made in the tax return. In the event a counteraction notice is not issued, or an enquiry is not made, the additional tax may never become due.
Claritas has a wealth of experience in agreeing HMRC clearances in all sorts of circumstances. We can also advise taxpayers through all elements of a deal process to ensure the intended and best possible outcome.
