A recent First-tier Tribunal tax case Wilkinson TC 08887 highlights that, with care, families can maximise Business Asset Disposal Relief (the successor to Entrepreneurs' Relief, often referred to as BADR), by dividing up a shareholding, pre-sale, between family members.
This case is also a useful reminder to consider whether tax clearances should be updated to reflect any change in the facts described before a transaction takes place: had the Wilkinsons refreshed their clearance application, HMRC may well have considered itself unable to take counteraction.
The fact in the case
In the case, four days before the sale of their company, Mr and Mrs Wilkinson transferred some of their shares to each of their three daughters. The parents and children claimed hold-over relief under s.165 TCGA 1992 such that the parents were not liable for capital gains tax on the gift of their shares to their daughters.
The company was then sold. Each daughter received 'A' loan notes and B ordinary shares in the purchasing company. Mr and Mrs Wilkinson and three other existing shareholders each received cash payments and the issue of two types of loan notes by the purchasing company: 'B' loan notes and earn-out loan notes.
The A and B loan notes carried no coupon and were on similar terms except that claims under the SPA were to be set off in priority against the B loan notes. The daughters were appointed as unpaid non-executive directors of a subsidiary of the company to be engaged for one year or 'if later, the date of repayment of all loan notes due to you.'. The earn-out loan notes paid out if the company hit certain hurdles post sale.
One year and one day after the sale of the company, each of the daughters redeemed their loan notes for £10m and sold their shares to a group company for their nominal value of £50 and the following day they resigned their directorships. The daughters each claimed Entrepreneurs' Relief, on the basis that their shareholding by virtue of their directorships qualified them for Entrepreneurs' Relief on their capital gains tax liability on the eventual disposal.
The tax clearance position
The parents and daughters had claimed hold-over relief and then, on the sale of the company, to the extent that the consideration was not in cash, they treated that sale as qualifying for roll-over relief - deferring the capital gains tax disposal event to the extent non-cash consideration was received until the eventual redemption of loan notes and sale of shares.
It is possible to obtain clearance in advance from HMRC that HMRC will not subsequently issue a counteraction notice and deny roll-over relief. That clearance seeks confirmation that HMRC are satisfied on the basis of the facts put to them that the transaction is for bona fide commercial reasons not forming part of a scheme or arrangement of which the purpose, or one of the main purposes, is tax avoidance. Part of the clearance also commonly seeks comfort on the transactions in securities rules that HMRC will not seek to counteract capital gains tax treatment and apply income tax treatment, but those provisions were not the focus of the case.
A previous sale of the company had aborted after issues with a licence and pricing discussions, but there were also implications that a factor had been a failure to obtain clearance from HMRC. A few months before the eventual sale of the company, tax clearances had been obtained for two alternative proposals: one involving a release of equity and the other on similar but not identical terms to the eventual sale.
The tax clearance on similar terms had referred to the gift to the daughters (but a slightly different number of shares was quoted) and that all the shareholders would sell for cash, shares and loan notes (but in the event the daughters did not receive cash and only the daughters received share consideration).
The ability for each of the daughters to obtain Entrepreneurs' Relief as well as Mr and Mrs Wilkinson was clearly important. The heads of term referred to the 'tax planning measures' and referred to how the buyer was required to give comfort that it was happy that the proposals did not fetter the buyer's 'absolute control' of the company and that 'it is understood that the shares to be issued to certain of the sellers "will have no substantive value (and will be capable of being purchased for a nominal price under the put/call arrangements)'.
Mr Wilkinson wrote to the daughters explaining the benefit to the family as a whole of the proposal and it was made very clear that the participation by the daughters was for tax mitigation reasons. However, the tribunal also found that Mr Wilkinson would have proceeded even if the capital gains tax planning could not have been achieved.
What was HMRC's central argument?
HMRC argued that roll-over relief was not available on the sale of the company and so capital gains tax was due for the year in which the sale took place. The daughters were therefore assessed for additional capital gains tax on the basis that Entrepreneurs' Relief was not available (because if roll-over relief were not available, at the time of their disposal of the shares in the company they did not meet the conditions having not been employees or officers of the company for the requisite period) and all the sellers were assessed for tax a year earlier than they had filed.
What approach did the tribunal take?
The tribunal in Wilkinson referred to the case of Snell in which the High Court had held that 'scheme' takes its ordinary meaning of 'a plan of action devised in order to attain some end' and Coll, in which the Upper Tribunal concluded in a judgment that found for HMRC that if one of the shareholders (other than unconnected shareholders holding 5% or less) failed the motive test then roll-over relief was denied for all the shareholders. The tribunal also referred to the Upper Tribunal's decision in Euromoney, in which the Upper Tribunal expanded the conclusion in Snell to say that the approach should be to make the following findings of fact:
- Does the exchange of shares or securities for other shares or securities form part of a 'scheme or arrangement'?
- What does the scheme or arrangement consist of?
- Is the main purpose or one of the main purposes of that scheme or arrangement the avoidance of liability to capital gains tax or corporation tax? What is the purpose or purposes of the totality of the scheme or arrangements? What is the purpose or purposes of the individual steps or constituent parts of the scheme or arrangement?
- What is the overall purpose of the scheme or arrangement?
The Upper Tribunal expressly noted that no view was being given as to whether the correct approach was subjective, objective or both.
The tribunal in Wilkinson applied the tests above and concluded in favour of the Wilkinsons that:
- the exchange was the sale of the company by all of the shareholders in return for the cash, loan notes and shares
- per Snell a scheme or arrangement has to have an end or a purpose
- the end or purpose was the sale of the company
- the exchange was part of that scheme or arrangement because the sale of the company was the aim of which the share for share/loan note exchange formed part
- 'on a realistic view of the facts, the Wilkinsons' CGT planning was not a self-standing scheme or arrangements separable from the deal as a whole' but that even if it were then 'on a realistic view of the facts, the exchange did not form part of it: the exchange was a significantly "larger" endeavour than the Wilkinsons' CGT planning, not least because it involved shareholders that had no part or interest in the Wilkinsons' CGT planning'
- the test should not be applied merely by reference to the daughters' part in the exchange - here the tribunal distinguished Snell where there was one 91% shareholder whose two sons held the balance of the shares, from this case where there were three shareholders uninterested in the putative 'scheme or arrangements' who between them held c.42% of the ordinary shares. It noted that Snell was decided before Coll and that Coll subsequently established that there is a single 'exchange' for the purposes of applying the test
- as a matter of fact, the goal of enabling the CGT planning was not the main purpose or one of the main purposes of the deal: the main purpose was the sale of the company, there was a large minority of shareholders who had no stake in the planning, the value of the planning was small in the overall context of the proceeds of sale, the buyer could walk away if it was not happy with the proposal (as to which point, I do not entirely follow the reasoning given the drafting of that condition in the heads of terms), it was clear that Mr Wilkinson would not have scuppered the deal if the planning could not be achieved and the share purchase agreement was not to protect the tax result or adjust the price in the event that the planning was not effective
- no adverse inferences should be drawn from the lack of evidence given to the tribunal by the daughters or Mrs Wilkinson
- obtaining the tax advantage was a purpose but not a main purpose.
Conclusion
Since the facts in the decision, changes have been made to the legislation to extend the qualifying period from one year to two, cap the chargeable gains that can qualify for the 10% relief rate at £1 million rather than £10 million and require that the minimum shareholding to qualify for relief is 5% of the ordinary share capital that provides full economic rights to dividends and on a winding up as well as full voting rights.
The benefits of BADR are therefore more restrictive than they were in 2016 when the Wilkinson family took steps to sell their company, but the outcome is still of interest both to families planning to sell the family business and also more generally to the application of the 'main purpose or one of the main purposes' test.
