HMRC wins tax avoidance case
04 August 2010
A share-for-share exchange designed to help one shareholder avoid tax is likely to affect innocent shareholders, preventing them from obtaining rollover treatment.
John Coll and Marian Coll v The Commissioners for Her Majesty's Revenue and Customs
Where shares in a company are sold to another company, it is common for vendors to take part of their consideration in the form of shares or loan notes in the purchasing company. It is possible to structure the transaction so that it does not involve an immediate disposal of the vendors' shares for the purposes of tax on capital gains. The shares or loan notes in the purchasing company will be treated as the same asset as the shares in the target company, and there will be no taxable event until the consideration shares or loan notes are sold, redeemed or otherwise disposed of.
However, this treatment is disapplied where the transaction 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." In these circumstances, deferral of tax is not possible and the initial share sale is a taxable event.
This disapplication rule will apply where a vendor takes loan note consideration with the intention of deferring liability to capital gains tax, intending that he will leave the UK and that the loan notes will be redeemed while he is non-resident and outside the scope of UK capital gains tax. In these circumstances, tax deferral will be unavailable – the exchange of shares for loan notes will be a taxable event and the liability will arise before the vendor has ceased to be UK tax resident.
However, the scheme or arrangements must exist at the time of the transaction. So there could be a temptation for vendors to sell their company for loan note consideration (to defer liability to tax), become non-UK resident and then redeem their loan notes - and say that at the time of the share sale, they did not have any plans to leave the country before redemption of the loan notes. Such a contention could be difficult for HM Revenue and Customs to disprove, as it depends on what the vendors' subjective intentions were at the time of the share sale.
A taxpayer and his wife took this line in the recent tax case of John Coll and Marian Coll v The Commissioners for Her Majesty's Revenue and Customs. The taxpayers sold shares in their company for loan note consideration and ceased to be resident in the UK before the loan notes were redeemed. They argued that the exchange of their shares for loan notes in the purchasing company should not be treated as an event of charge to capital gains tax – the charge should be deferred until they redeemed their loan notes, by which time they were non-resident and so outside the scope of capital gains tax.
However, if the exchange of shares for loan notes formed part of a scheme or arrangements to avoid capital gains tax, this treatment would not apply – a disposal for capital gains tax purposes would be treated as taking place at the date of the exchange, when they were still UK resident.
The taxpayers argued that, at the date of the initial sale, they were not planning to go non-resident and redeem their loan notes – so they had not entered into a scheme or arrangements to avoid capital gains tax.
Unfortunately for the taxpayers, neither of the two tax tribunals which have heard their case believed them. The Special Commissioner made a number of findings of fact against the taxpayers and these were upheld by the Upper Tribunal on appeal, which stated that "We consider that there was ample evidence on which the Special Commissioner could come to [his] conclusion…and disbelieve the Appellants' story."
The decision is also of note for a technical tax point which arose. The Upper Tribunal held that, even if only one of a number of shareholders has entered into a scheme or arrangements to avoid tax, this can affect the tax position of all the shareholders – including shareholders who have nothing to do with the tax avoidance arrangements.
There may be circumstances in which a group of shareholders are selling a company in exchange for the issue of shares or loan notes in the acquiring company, and one of the shareholders is entering into a tax avoidance scheme in connection with the sale. In these circumstances, the activities of the single tax-avoiding shareholder could adversely affect the tax position of the other "innocent" shareholders. All the shareholders could be treated as making an immediate disposal of their shares for capital gains tax purposes, rather than deferring the tax charge until the shares or loan notes in the purchaser are sold, redeemed or otherwise disposed of.
For further guidance on these issues please contact John Barnett by email or telephone on +44(0) 117 902 2753.