TRANSACTIONS IN SECURITIES 2010: THE NEW CODE

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1 TRANSACTIONS IN SECURITIES 2010: THE NEW CODE STEPHEN BRANDON Q.C. 1 FA 2010, Schedule 12 enacts the new rules on transactions in securities. It follows, aside from a few minor, and one major, point (dealing with foreign companies) the draft in the 2009 Consultative Document. It does contain some welcome simplification and narrowing of the target area. In this HMRC are to be congratulated. 2 What may not have been generally appreciated, however, is a number of uncertain and difficult questions which it raises. To a considerable degree, the answers will depend on how far we follow through certain deemings. I am not, therefore, seeking to provide a comprehensive summary of what the new provisions say: there are already several of those. What I say below summarises some of the questions raised in my lecture at the London Key Haven Conference on May 5 th. It will appear as a more extensive article but this article is meant to provoke thought. 3 The transactions in securities rules have always set traps for the unwary, e.g. in reorganisations. This is particularly so where new finance is being introduced and existing shareholders are reducing their holdings, typically being bought out by a new holding company funded by bank finance. The ITA 2007 section 682 etc. rules potentially charge the consideration received by the shareholders to income tax. 1

2 4 A problem with understanding the existing rules is that there is a considerable bank of case law, much of which is counter-intuitive. The law cannot be understood merely by reading the words of the sections. We need to see how much has changed with the advent of the 2010 revisions. 5 In particular, points of concern relate to: 5.1 the lack of express transitional provisions in respect of the rules in ITA 2007, section 682, etc., in force before 24th March 2010 ( the Old Code ); 5.2 which of the authorities on the Old Code are still relevant; 5.3 whether (and how) the burden of proof has shifted; 5.4 how much narrower than the old Circumstance E is Condition B; 5.5 how far the deeming following from the reference to qualifying distribution in the definition of income tax advantage in the new section 687(1) goes; 5.6 problems with the last minute addition of companies which would be close if UK resident (call them foreign close companies ); 5.7 whether the introduction of foreign close companies removes any benefit of the remittance basis. 6 These points, of course, overlap to some degree. In this brief article I assume that the reader is familiar with the Old Code (and the major authorities on it) and has had a go at interpreting the rules in force from 24th March 2010 ( the New Code ). 2

3 7 Lack of Transitional Provisions 7.1 Generally, the New Code came into force on 24 th March 2010 and the terms of the relevant sections in the Old Code were repealed from that date. Several questions are, however, left unanswered. For instance: what happens if a transaction in securities (defined in the Old Code but substantially similar in the new Code) 1 occurred before 24th March 2010 but the relevant consideration is received afterwards; what happens if the Circumstance under the Old Code (typically Circumstance D or E) occurred before 24th March but the relevant consideration is received afterwards; more particularly, what if securities within the old Circumstance E, paragraph (2) exception were received before 24th March but the repayment of the share capital occurs afterwards? Prima facie a number of transactions will fall out of charge but a brief review of the provisions may be misleading. 8 Need for Transitional Provisions? 8.1 Looking at what transitional provisions there are, which are principally the timing provisions in Schedule 12, paragraph 15(1), the rules referred to below came into force on 24 th March The substantive provisions in paragraph 2 merely substitute the New Code for the Old Code. They... have effect in relation to income tax advantages obtained on or after 24 th March Their effect includes the repeal of sections 682 to 694 of the Old Code. 1 See ITA 2007 section 713 of the Old Code. 3

4 8.2 Suppose that the only transactions in securities and Circumstance occurring did so in February 2010 but the relevant consideration is received in June. It is by no means clear how the New Code taxes that relevant consideration by reference to facts falling within (then) the old Circumstance D of the Old Code. 8.3 A still more interesting question is: what if the facts occurring in February 2010 would also fall within the new Condition A, had it been in force then? But Condition A did not come into effect until 24 th March. Paragraph 15(1) and (4) merely tell us, from that date, what is repealed or in force. 8.4 This minimalist approach can be compared with the extensive transitional provisions in FA 2008 dealing with the new rules on remittances. 8.5 HMRC may point out, however, that the New Code merely inserts certain provisions into an existing code, so that no transitional rules are needed. We have a single continuous code parts of which have been (considerably) amended. What happens if we conceptualise the law in terms of a single code with variations in defining a term from time to time? Does this obviate the need for transitional provisions? One can see the attraction of the argument to HMRC and the courts but is this a tenable construction? 8.6 The argument is that we look for an income tax advantage from 24 th March and then apply the new rules in relation to that. One still needs, however, to look for the satisfaction of a defined term at a particular time, so that the argument has to be that we are interpreting (say) section 685 as in force from 24 th March in respect of the events in February. Even then, where does this leave an income tax advantage obtained before 24 th March where the (say) distribution of profits is afterwards? 2 It is by no means certain that the simplistic view set out in paragraph 8.5 is correct. 2 Say, where target placed under a new holding company pays up its profits, as is not unusual, to fund bank borrowings. 4

5 9 The Old Authorities 9.1 These are crucial to the understanding of the Old Code. Many of its provisions were extremely widely interpreted. It is of course possible that a Tribunal may hold that none of the old authorities is relevant. I do not think so: too many concepts are similar so that many of the relevant authorities ought at least to be persuasive. The trick is to work out which ones are still relevant. This is not easy. 9.2 The first issue is one of approach. The Old Code was interpreted widely as constituting a massive attack on tax avoidance: see Joiner. 3 This was before Ramsay. Why should the New Code be so interpreted? Since, however, Ramsay is in reality (now) a principle of the purposive interpretation of taxing statutes (ignoring certain aberrations), how far does this argument take us? The last line of cases on the Old Code did not show an abandonment of the Joiner approach. 4 The point now is that the purposes of the New Code have been set out by HMRC in the Consultative Document: it is not a general attack on tax avoidance but a much more focused code, hence the removal of the old Circumstance C. To what extent, then, should the approach from Joiner still be relevant? Cleary 9.3 Determining which authorities are still relevant requires very careful study of each subsection. 5 Take, for example, the pivotal case of Cleary, 6 where it will be remembered that the sisters owned two companies and sold shares in one to the other, receiving cash from the (new) parent company. It is not readily appreciated that whilst Cleary concerns a sale of shares at market value, it could just as well have been a sale of anything (assuming a relevant transaction in See 50 TC 480. See e.g. Sema Group Pension Scheme [2003] STC 95. As well, of course, of the considerable breadth of authority. 44 TC

6 securities somewhere). The cash consideration for which full value was given was caught by the Old Code. Is this still good law? 9.4 There are several points. For example, the new definition of income tax advantage in section 687, subsection (1),(a) requires us to ask what would be the case if the relevant consideration were a qualifying distribution. This is a technical term: Corporation Tax Act 2010 section It brings with it considerable baggage, including the definition of distribution. Thus if a company receives new consideration there is no distribution on a receipt by the shareholder representing that value. 7 Under the Old Code, the giving of value was irrelevant. If, however, full value new consideration such as were the shares in the company sold by the sisters to the (new) parent company in Cleary is given, there should be no qualifying distribution. Has, therefore, Cleary been overruled? See below. 7 CTA 2010 section

7 Wiggins 9.5 Again, what of Wiggins, 8 one of the more extreme decisions under the Old Code. There, it will be remembered, the shareholders caused a new company to be incorporated ( New Wiggins ), to which the trading assets of Old Wiggins (other than the very valuable Poussin) were sold. Old Wiggins (with the Poussin) was sold to an outside art dealer. The consideration received from that dealer was held to be taxable with Circumstance D applying. Amongst other mad things held there, Walton J said that the identity of the paymaster is irrelevant. With a qualifying distribution, however, the identity of the paymaster (although query how direct) is surely crucial. 9 Is there any reason now for this part of the Wiggins analysis to apply? (I deal with how far the deeming goes in respect of qualifying distribution below.) Laird Group 9.6 Does Laird Group 10 still apply (so that a dividend is not a transaction in securities )? This partly hinged on the reference in the Old Code to a liquidation not being a transaction in securities. That reference, however, has gone, although this was assumed not to matter in the Consultative Document 11. The speeches in the House of Lords in Laird Group, however, show how relevant this provision was in reaching their conclusion. There is, though, in the speeches, some help, particularly concerning the differences of opinion in the House of Lords in Greenberg and the conceptualisation that explains the link between a liquidation and a dividend [1979] STC 244. But this of course depends on how far we follow through the deeming: see below. [2003] UKHL 54. Paragraph 3.3, where it is stated We consider that the proposed legislation should be capable of covering this type of situation, without the need to deal with it separately. 47 TC

8 10 Burden of Proof 10.1 The burden of proof in a tax case is nearly always cast on the taxpayer. This was not the case for the purposes of the Old Code (except for the motive defence). Is this still the law? Arguably not but do not panic: perhaps the burden of proving the absence of the motive defence is now on HMRC as well! 10.2 Why was it the case that the burden of proof was cast on HMRC? The issue requires a thorough understanding of the judgment of Slade J at first instance in Garvin 13 and the authorities he cites there. Briefly, the taxpayer bears the burden of proof under TMA 1970, section 50, subsection (6) when discharging an assessment (or amendment to a return). Under the Old Code, however, there had to be certain facts proved before a counteraction notice could be served (rather like an allegation of a change of domicile). Thus, following the general rule, the person who alleges must prove It would seem that this should still be the case under the New Code but look at the structure of section 684, especially subsection (1), (c). There is no self-contained rule expressly requiring the taxpayer to show something. Rather, one of the pre-conditions for charge is the existence of a tax avoidance motive. This would seem to indicate a very generous move by HMRC, to shift the burden of proof here, which will be warmly welcomed by all taxpayers of a sunny disposition. 11 The Conditions 11.1 These have a narrower ambit that the old Circumstances and require very careful study TC 24. 8

9 11.2 Look, e.g., at Condition B (similar to the old Circumstance E). A crucial question is: does the relief in Circumstance E(2) (now section 685, subsection (7)) still trump the charge in Condition A (the old Circumstance D), as held by the Court of Appeal in Williams? 14 This can be extremely important in planning, since a charge under section 684 can be postponed, with care, for good. The answer is that it does How is Condition B narrower than Circumstance E? Take one point. The new shares or security must be issued by a close company but it must (say) represent assets available for distribution of that close company. This is a very helpful simplification. Circumstance E was wider in a manner which often caused problems. 12 Deeming and a Qualifying Distribution 12.1 Section 687, subsection (1), (a) states: (1) For the purposes of this Chapter the person obtains an income tax advantage if- (a) the amount of any income tax which would be payable by the person in respect of the relevant consideration if it constituted a qualifying distribution exceeds the amount of any capital gains tax payable in respect of it 12.2 This is the most troublesome new provision. Under the Old Code, there was no definition of income tax advantage but in the House of Lords in Parker 15 Lord Wilberforce set out the definitive test, i.e. briefly, look at the receipt and ask if the taxpayer could have obtained it subject to income tax (so far, by a comparison with a dividend). This definitive test lasted a whole year until Vct. Dilhorne in Cleary clarified it by deciding that we are not concerned with how the receipt was obtained: the hypothesis is simply to ask if TC TC 399 9

10 what was actually received (usually, cash) could have been received subject to income tax. Hence why a loan is caught Now we have a statutory definition in section 687 (1). The it first referred to in paragraph (a) refers to the relevant consideration which is defined depending on whether Condition A or Condition B applies, but, in a nutshell, refers to what the taxpayer actually receives As touched on above, it is by no means clear how far we follow the deeming through. There would seem to be three principal possibilities: we look at the actual consideration received and the circumstances of receipt. This is the approach, implicitly, of Lord Wilberforce in Parker; we look at the actual consideration received, but ignore the precise circumstances of receipt. This is the approach of Viscount Dilhorne in Cleary, qualifying Parker; we simply assume a hypothetical qualifying distribution of a value equal to what is actually received If the correct answer is the first possibility, Cleary has been overruled so that the New Code is very much narrower than the Old Code. Another different way of putting this point is: do we therefore bring in all the rules relating to qualifying distributions and apply them to what was actually received, and the way it was received? Thus, issues of new consideration, which were irrelevant under the Old Code (within the Parker/Cleary meaning of tax advantage ) will be crucial under the New Code. Planning under it would, potentially, be transformed If, however, we assume a hypothetical qualifying distribution, equal to the value of what has actually been received, there is an obvious 10

11 analogy to be drawn with Cleary, which should remain a relevant authority There is, I think, much to support a much narrower interpretation of section 687, read in context but see below. 13 Foreign Close Companies 13.1 Anyone who has read the responses to the Consultative Document may well have formed the view that leaving out foreign close companies was an oversight, put right in the Bill A company which is not within the charge to corporation tax (i.e. most foreign resident companies) cannot make a qualifying distribution. How, then, do we interpret the income tax advantage in respect of a foreign resident company? The concern, of course, is that a Tribunal may be inclined to go with the third possibility in paragraph 9.3 to make the thing work. 14 Remittances and Foreign Close Companies 14.1 Does the remittance basis apply in respect of a charge under section 684 where the receipt is from a foreign close company? Not on a technical analysis. The only relevance has to be at the stage of determining if there has been an income tax advantage Necessarily, we come back to a comparison similar to the Parker test: a hypothetical (foreign) dividend would have to be remitted to be taxable (for a foreign domiciliary) Under the New Code we refer to section 687 and our (deemed) qualifying distribution. If we go with the hypothetical qualifying distribution is that not (necessarily) from a UK resident company? Leave aside PE issues. 11

12 14.4 If so, does this mean the remittance basis is irrelevant? (Personally I doubt that a court would go so far but a Tribunal might if it got a sniff of avoidance). 15 Conclusions 15.1 As will be appreciated, this is a summary of some of the difficult but very important questions raised, many of which do not seem to have been generally appreciated yet. The New Code raises many very difficult issues, the answers to several of which are not clear. It is a pity that the document dealing with responses to the Consultative Document only seems to deal with what one might call bread and butter concerns and not the difficulties caused by the drafting and its interrelation with both existing authorities and the Old Code Whilst the brevity and narrower focus of the New Code are very much to be admired, advising on it will, as with the Old Code, require a very careful study of the legislation, a thorough understanding of the authorities on the Old Code and a rigorous analytical approach. Do not, for one moment, assume that the law has got that much simpler. The opportunities and pitfalls are simply different. 12