While it is tax legislation that defines the UK’s tax system rather than HMRC, getting HMRC’s rubber stamp to approve a transaction prior to proceeding is always preferable.
This seal of approval can be obtained by submitting a clearance application to HMRC in advance to confirm the tax treatment of a transaction or event, where possible. Obtaining clearance from HMRC provides certainty and reduces the risk of future enquiry or investigation. However, there are a lot of misconceptions on what clearance is, when clearance can be applied for and what it means for the relevant parties.
What is a Clearance Application?
Advance clearance can be applied for from HMRC in certain specified circumstances. In a nutshell, clearance from HMRC is their written verification of the application of tax law to a transaction. There are two forms of clearance applications available: the statutory clearance procedure and the non-statutory clearance procedure.
Broadly, the difference between the two clearance facilities is what it says on the tin. Statutory clearances are those which the legislation specifically provides for. Conversely, non-statutory clearance applications can essentially be made in respect of the application of any tax law but are only available where there are genuine points of uncertainty in the legislation.
When can Clearance be applied for?
In reality, even though the list of statutory clearances is long, the circumstances in which they can be applied for is limited. We don’t propose to go into detail about what clearances can be applied for in this article but instead the focus is the high-level and practical reality of clearance applications made.
The most common statutory clearance applications that we deal with in the owner-managed business sector include:-
- Company reconstruction and reorganisations such as share for share exchanges or demergers for capital gains tax purposes to ensure no capital disposal and resulting tax charges are not triggered for shareholders;
- The ‘transactions in securities’ anti-avoidance provisions for income tax purposes where shareholders extract value from the company to ensure the value extracted is not subject to income tax at dividend rates; and
- Company purchase of own shares to confirm capital treatment for the shareholders to ensure the proceeds are subject to Capital Gains Tax (“CGT”).
Broadly, these confirm that HMRC accept that the transactions are being undertaken for commercial purposes and not for the avoidance of tax and that the transaction is treated as a capital transaction for the shareholders subject to the CGT provisions rather than being subject to the higher rates of income tax. Given the differential tax rate between CGT at 20% (or 10% where the shareholder qualifies for Business Asset Disposal Relief) and income tax rate at up to 39.35% on dividends receiving, confirmation from HMRC of this is very valuable. It also provides the taxpayer with certainty ahead of implementing the transaction to give them peace of mind.
Non-statutory clearance applications can be requested in respect of the application of any tax legislation where there is uncertainty in the legislation. Typically, HMRC’s view on what amounts to a genuine point of uncertainty has become narrower in more recent years, which has made the possibility to obtain a view from HMRC via the non-statutory clearance application procedure more difficult. For example, HMRC will no longer comment on what constitutes a business for the purposes of certain tax reliefs. However, the non-statutory clearance application to confirm Business Property Relief on the transfer of shares into trust for inheritance tax purposes is still widely used where the circumstances warrant such an application. A judgement on what is a genuine point of uncertainty in the legislation needs to be determined by a qualified tax advisor otherwise the process is costly and frustrating when HMRC come back with an unhelpful response to state there is no uncertainty upon which to provide comment. It also goes without saying that HMRC will not give non-statutory clearance to confirm their view of the tax position in respect of transactions that they consider to involve tax avoidance.
What does Clearance mean for the relevant parties?
In an attempt to dispel some of the myths and misconceptions about what clearances really mean, we outline a list of common assumptions about clearances and whether they are fact or fiction.
“Statutory clearances are compulsory and without them the tax position of the shareholder is adversely effected.”
One of the misconceptions with statutory clearances is that they are compulsory and that in order for the tax treatment to apply, clearance has to be received from HMRC. This is not true, and while it is preferable to obtain clearance it is not essential. For example, where HMRC response delays cannot be built into the transaction timetable it may be that commercially the transactions proceed without clearance and instead a defence paper is prepared to document the risks, if any.
“Clearance from HMRC guarantees the shareholder’s tax position.”
Another common misconception is that the clearance from HMRC confirms all tax analysis to a particular transaction, when in most cases the clearance provided is very specific. For example, company reorganisation and reconstruction clearances confirm that HMRC accept the transactions are being undertaken for bona fide commercial reasons and not for the avoidance of tax, but they do not strictly confirm anything else, including whether the reorganisation and reconstruction reliefs apply to the transaction set out. Similarly, the purchase of own shares clearance to confirm capital treatment applies does not confirm Business Asset Disposal Relief and the relevant 10% CGT rate is available. Furthermore, HMRC do not comment on the valuation as part of the clearance procedure, even where valuations are referred to in the application. Separate tax analysis (and a valuation exercise, where appropriate) needs to be undertaken in order to conclude on the resulting tax position for the taxpayer, once clearance has been received. The crucial takeaway point is knowing what the clearance provides, its limitations and the additional analysis that is required in order to confirm the tax treatment in full.
“Unless the clearance sets out the exact circumstances of the transaction in full, the response from HMRC cannot be relied on.”
It is fundamental that the facts of the case are set out in the clearance in order to be able to rely on the response provided by HMRC. As recent case law has confirmed, without this, the response from HMRC isn’t worth the paper it is written on and they can reverse their opinion previously provided at a later date. Furthermore, the transaction has to be carried out exactly as described within the clearance in order to rely on HMRC’s response and if there are changes to the transaction it is prudent to keep HMRC informed to request that their response has not changed.
“If HMRC denies clearance the transaction cannot go ahead or if it does go ahead the shareholder has to pay penal rates of tax.”
In the event a negative clearance application is received it doesn’t necessarily mean that the transaction cannot go ahead but the risk that adverse tax consequences will arise are higher and there is generally no right to appeal against HMRC’s decision. Firstly, there is the internal review process where the clearance response can be referred to another HMRC officer to consider the initial response, and in respect of share reorganisation clearances a referral to the tribunal to overturn the decision can be made. Furthermore, in some circumstances e.g. the transactions in securities provisions, the onus is on HMRC to issue a counteraction notice to issue the income tax that would be due and the taxpayer cannot self-assess the tax on their tax return. The key point is that if a negative clearance is received, we do not have to agree with HMRC’s view and the response can be disregarded. However, it is essential to make full disclosure in the tax return of the filing basis, regardless of whether or not HMRC grant clearance. In the event a counteraction notice is not issued, or an enquiry is not made, the additional tax may never become due.
“The clearance application process can cause delays in the transaction process so time should be built into the process.”
HMRC has 30 days to respond to statutory clearance applications and there is no response time limit for non-statutory clearance applications. Furthermore, when HMRC respond they can either grant clearance, deny clearance or ask more questions. Each round of correspondence is then subject to the same timeframes. Due to the change of personnel in the reconstructions team and resource issues at HMRC, advisors have found that statutory clearance applications are now taking several rounds of correspondence to be concluded and several weeks for non-statutory clearances. Furthermore, a poorly drafted clearance application increases the risk of questions and delays and therefore the drafting of clearances should be left to those that are experienced in doing so. If the clearance process is managed efficiently and carefully it should not cause unnecessary delays to the transaction. We would always recommend applying for clearance as soon as the facts of the transaction are known so that other workstreams can continue in the background while waiting to hear back from HMRC. However, HMRC’s response timeframes are outside of all parties’ control.
To conclude, clearance applications are often the go-to for tax advisors but should be left to those who are experienced in drafting them to maximise the chances of a positive result for the taxpayer. By getting the green light to proceed from HMRC it gives the taxpayer the peace of mind, but the accompanying tax analysis required for the transaction alongside the clearance is essential.
