Simplifying Transactions in Securities Legislation Consultation Document 31 July 2009
Subject of this consultation: Scope of this consultation: Whether a package of proposals aimed at simplifying the Transactions in Securities legislation fulfils the twin aims of revenue protection and simplicity whilst providing clear benefits for customers. We are seeking opinions on a package of proposals to simplify and clarify the existing Transactions in Securities legislation. Whilst the proposals contained in this consultation document relate to changes to sections 682-713 Income Tax Acts 2007, which cover income tax advantages, the intention where possible would be to replicate the same changes for Corporation Tax advantages, the current legislation on which is being rewritten with a view to inclusion in the proposed new Corporation Tax Act 2010. Proposal 1 considers refocusing the purpose test to target tax avoidance. A separate discussion document considers simplification of unallowable purpose tests. It can be found at http://www.hmrc.gov.uk/consultations/ Impact Assessment: Please see the Consultation Stage impact assessment for this package of proposals. Who should read this: Duration: Enquiries: Any customer, advisor or representative body that has experience of working with the anti-avoidance provisions in sections 703 to 709 Income and Corporation Tax Acts 1988 and sections 682 to 713 Income Tax Acts 2007. The consultation will comply with the Government Code of Practice. All responses should reach HMRC by Friday 30 October 2009. All enquiries regarding the content or scope of this consultation or further information about the consultation should be addressed to: Telephone: 020 147 3684 Fax: 020 7147 0128 HM Revenue & Customs, Business Customer Unit, Room 3/46, 100 Parliament Street, London, SW1A 2BQ Email: anti-avoidance.simplification@hmrc.gsi.gov.uk How to respond: Additional ways to become involved: Written responses can be made to Mr Hussein Saleh at the above address or the above email address. In order to engage as wide an audience as possible with the consultation, we would be happy to meet with customers, advisors and representative bodies if they consider that this will add to our understanding of the issues faced by customers. Please use the contact details above if you wish to arrange such a meeting. HMRC proposes a workshop for external stakeholders in early September 2009 to further consider and inform opinion of the issues raised in this discussion document on simplifying unallowable purpose tests. Please use the contact details below if you would like to attend this workshop providing your name and contact details. Customers, advisors and representative bodies may also want to consider the separate review on simplification of unallowable purpose tests at http://www.hmrc.gov.uk/consultations. After the consultation: A summary of the responses to this consultation will be published. Emerging findings will inform Government decisions in respect of the simplification of the Transactions in Securities legislation in the period leading up to Budget 2010. 2 Simplifying Transactions in Securities Legislation
Getting to this stage: Previous engagement: Customers, advisors and representative bodies have been involved from an early stage to help identify the legislation to review and develop initial proposals. As part of the 2007 Budget, the Chancellor announced a series of consultations with external stakeholders to identify specific areas of anti-avoidance legislation in need of change. The proposals contained in this consultation document represent the results of those external workshops and associated follow-up work. External stakeholder workshops with customers, advisors and representative bodies were held at the start of September 2008. Between September 2008 and January 2009, we held a number of further one-to-one meetings with external stakeholders. In January 2009 an additional workshop with a small number of external stakeholders was held, where we developed a set of draft proposals which form the basis of this consultation document. 3 Simplification Transactions in Securities Legislation
Contents Chapter no. Chapter title Page no. 1. The Consultation Process 5 2. Introduction 6 3. Proposal 1: Refocus the Transactions in Securities legislation to target tax avoidance 9 4. Proposal 2: Adopt the definition of a close company for 'Relevant Company' in section 691 ITA 2007. 11 5. Proposal 3: Simplifying the remaining circumstances in sections 686 to 690 ITA 2007. 13 6. Proposal 4: The fundamental change of ownership rule 16 7. Proposal 5: Defining and quantifying 'Tax Advantage' 18 8. Proposal 6: Clarifying the scope of the Transaction in Securities legislation 20 9. Proposal 7: Framework guidance for Transactions in Securities 21 10. Summary of consultation 23 Annex A The Government s code of practice on consultation 25 Annex B List of abbreviations used 26 Annex C Draft amendments to ITA 2007 27 Annex D Draft guidance for Transactions in Securities legislation sections 682 to 713 ITA 2007 31 Annex E Current ITA 2007 legislation 52 Annex F Current ICTA 1988 legislation 60 Annex G Impact Assessment 65 4 Simplifying Transactions in Securities Legislation
1. The Consultation Process 1.1 How to Respond A summary of the questions in this consultation is included at Chapter 10; Summary of Consultation. A list of all the abbreviations used in this document is at Annex B. Responses should be sent by Friday 30 October 2009. By email to: Or by post to: anti-avoidance.simplification@hmrc.gsi.gov.uk; HM Revenue & Customs, Business Customer Unit, Room 3/46, 100 Parliament Street, London, SW1A 2BQ Telephone: 020 7147 3684 Fax: 020 7147 0128 This document can be accessed from the HMRC Internet site at http://www.hmrc.gov.uk/consultations. All responses will be acknowledged, but it will not be possible to give substantive replies to individual representations. When responding, please say if your response is on behalf of an individual, business, advisor, or representative body. In the case of individuals please provide details on your experience of the Transactions in Securities legislation. In the case of businesses please provide information on the size of your business, the nature of the industry in which you work and your experience of the Transactions in Securities legislation. In the case of advisors please provide information on the number and type of clients you work with and the nature of your work with them. In the case of representative bodies please provide information on the number and nature of people and or businesses you represent. 1.2 Confidentiality Information provided in response to this consultation, including personal information, may be published or disclosed in accordance with the access to information regimes. These are primarily Freedom of Information Act 2000 (FOIA), the Data Protection Act 1998 (DPA) and the Environmental Information Regulations 2004. If you want the information that you provide to be treated as confidential please be aware that, under the FOIA, there is a statutory Code of Practice with which public authorities must comply and which deals with, amongst other things, obligations of confidence. In view of this it would be helpful if you could explain to us why you regard the information you have provided as confidential. If we receive a request for disclosure of the information we will take full account of your explanation, but we cannot give an assurance that confidentiality can be maintained in all circumstances. An automatic confidentiality disclaimer generated by your IT system will not, of itself, be regarded as binding on HM Revenue and Customs (HMRC). HMRC will process your personal data in accordance with the DPA and in the majority of circumstances this will mean that your personal data will not be disclosed to third parties. 1.3 The Government s Consultation Code of Practice This consultation is being conducted in accordance with Government's Code of Practice on Consultation. A copy of the Code of Practice criteria and a contact for any comments on the consultation process is located in Annex A. 5 Simplifying Transactions in Securities Legislation
2. Introduction 2.1 Overview of this Consultation Document We are aware from consultations with stakeholders that customers, advisors and representative bodies consider the Transactions in Securities (TiS) legislation currently found at sections 703 to 709 Income and Corporation Tax Acts (ICTA) 1988 for corporation tax and sections 682 to 713 Income Tax Acts (ITA) 2007 for income tax to be extremely complex and unnecessarily cumbersome. There is, therefore, a clear argument for simplifying this legislation and clarifying its scope to ensure customers are not weighed down by unnecessary compliance burdens or excessive advisors fees. This consultation document proposes changes that would be made to Part 13, Chapter 1, sections 682 to 713 ITA 2007. The principles established by these changes will be replicated in to the Corporation Tax legislation. As part of the tax law rewrite, sections 703 to 709 ICTA 1988 are being rewritten for inclusion in the proposed Corporation Tax Act 2010 (CTA 2010). It is therefore proposed that Corporation Tax (CT) amendments are not made to ICTA 1988 but are instead made to the proposed CTA 2010. The specific changes to the proposed CTA 2010 are not covered in this consultation document. This consultation document details a package of proposals which HMRC consider meet the objectives of the Anti Avoidance Simplification Review for Transactions in Securities. Chapters 3 to 9 give further details on each proposal. At the end of each chapter there are a series of questions relating to each proposal to which we would appreciate your responses. Additionally, there are a number of questions at the end of this Chapter regarding the package of measures as a whole. When considering the proposals in this document, you should remember that we are not consulting on each proposal individually, but on all proposals together, as a single package. 2.2 History of the Legislation The TiS legislation was originally enacted in 1960 to combat specific income tax 'stripping' avoidance devices which, before the introduction of Capital Gains Tax, turned taxable income into tax exempt capital. Since 1960, its general power has protected the Exchequer against a wide range of avoidance schemes in shares and securities transactions which seek to exploit the differences in the rates of tax applying to income and Capital Gains. There have been a number of changes to the TiS legislation since 1960 that culminated in sections 703 to 709 ICTA 1988 covering both IT and CT. In 2007 the legislation was amended so that, from 5 April 2007, sections 703 to 709 ICTA 1988 cover only CT as the IT aspects of the TiS legislation are incorporated into sections 682 to 713 ITA 2007. In 2008, approximately 6,000 clearance applications were made of which approximately 2% were rejected. Most applications are processed quickly (the average time to process clearances in 2008 was less than 8 working days) because the majority of applications concern genuine commercial transactions with no tax avoidance motive, to which the TiS legislation does not apply. 2.3 History of the Anti Avoidance Simplification Review The Pre-Budget Report (PBR) 2007 launched the Anti-Avoidance Simplification Review, to consider how antiavoidance legislation can best meet the twin aims of simplicity and revenue protection. The PBR document set out the Government's view of how simplification can best be achieved in anti-avoidance legislation through ensuring new anti-avoidance legislation is clear, effective and well targeted and by simplifying areas of existing anti-avoidance legislation where appropriate. 6 Simplifying Transactions in Securities Legislation
At Budget 2008, HMRC published an update on the Anti-Avoidance Simplification review. (http://irscot.inrev.gov.uk/budget08/main/00notices/others/aa-simplification.pdf). This included a summary of the results of the initial engagement with business and professional stakeholders, who accepted the need for Government to ensure that anti-avoidance legislation provides effective protection to the Exchequer. However, they wanted legislation that is clear, well targeted and easier to use. Additionally they wanted to be able to understand the tax consequences of complex commercial transactions with reasonable certainty. On 17 July 2008, HMRC published an update paper providing further information on three areas that were subject to the Anti-Avoidance Simplification Review. http://www.hmrc.gov.uk/avoidance/avoid_report.pdf. These were: TiS legislation, Simplification of Unallowable Purpose tests and the rules on Employment Related Securities. Following this update paper, HMRC held a number of external stakeholder workshops with businesses, advisors and representative bodies at the start of September 2008. Between September 2008 and January 2009, we held a number of further one-to-one meetings with external stakeholders. In January 2009, an additional workshop with a small number of external stakeholders was held, where we developed a set of draft proposals which form the basis of this consultation document. 2.4 Effect of this package of measures The package of measures proposed in this consultation document will result in a fundamental and significant change in the approach and application of the TiS legislation. The aim is to give greater clarity and certainty to our customers which should lead to reduced compliance burdens. These proposed changes will focus the scope of the legislation to target TiS which had been entered into for a main purpose of obtaining a tax advantage. The proposed changes would provide greater clarity in relation to the calculation of any tax advantage and thus the amount potentially at stake in any counteraction process. The aim is to create clearer, more focused legislation, supported by guidance, which should help customers understand the specific behaviour being targeted, improve certainty about how and when the legislation applies and consequently reduce compliance burdens meeting the twin aims of the simplification review of simplicity and revenue protection. 2.5 Questions For the purposes of this consultation, the proposals should be considered as a single package of proposals, not as seven individual proposals. Specific questions for each proposal can be found at the end of each chapter. However, in addition, we ask respondents to provide responses to the following overview questions: 2.5.1 Do you welcome the package of proposals (as a whole) as simplification to the TiS legislation? 2.5.2 Does the package of proposals (as a whole) capture the main opportunities to provide customers with simplification and increased certainty? 2.5.3 Are there any additional areas you feel we should consider to further simplify the TiS legislation? 7 Simplifying Transactions in Securities Legislation
2.6 Summary of Proposals This document contains a package of seven proposals relating to the TiS simplification review on which we would like to obtain external opinions. In summary, these proposals cover: Proposal 1 Title of Each Proposal Refocus the Transactions in Securities legislation to Target Tax Avoidance 2 Adopt the definition of close company for 'Relevant Company' in section 691 ITA 2007 ('D2 Company' in section 704 ICTA 1988). 3 Simplifying the remaining circumstances in sections 686 to 690 ITA 2007. 4 The fundamental change of ownership rule 5 Defining and quantifying 'Tax Advantage' 6 Clarifying the scope of the Transaction in Securities legislation 7 Framework guidance for Transactions in Securities 8 Simplifying Transactions in Securities Legislation
3. Proposal 1: Refocus the Transactions in Securities legislation to target tax avoidance 3.1 Aim of the Proposal The aim of this proposal is to modernise the TiS legislation to ensure it is clearer and more focused. This should help customers understand what the legislation is targeted at and how it applies. This will increase certainty and reduce compliance costs. The refocused legislation should only catch customers who enter into TiS that have a tax avoidance purpose. What was previously described as the prescribed circumstances and the 'Escape Clause' will now be incorporated into a new purpose test at section 683 ITA 2007 removing the need for a separate 'Escape Clause'. 3.2 Current Position Broadly, the current TiS legislation means that a person is subject to counteraction (i.e. HMRC will issue a counteraction notice to the person in question effectively charging to tax an equivalent amount to the tax advantage gained from the TiS) if all of the following main conditions are met: (a) a person must be in a position to obtain (or have obtained) a tax advantage (section 703(1) ICTA 1988/ section 684(1) ITA 2007); (b) the tax advantage must be obtained (or obtainable) by that person in consequence of one or more TiS or in consequence of the combined effect of the TiS and the liquidation of a company (section 703(2) ICTA 1988 / section 684(3), ITA 2007); (c) the TiS falls into one of the four prescribed circumstances (section 704, ICTA 1988 / sections 686-690 ITA 2007); (d) the Escape clause does not apply - the person cannot show that the TiS is done for bona fide commercial reasons or in the ordinary of making or managing investments and gaining a tax advantage was not a main or one of the main purposes of the TiS (section 703(1), ICTA 1988 / section 685 ITA 2007). This basic approach potentially brings all TiS within the scope of the legislation and then uses filters such as tax advantage, the four circumstances and the escape clause to take some TiS out of the scope of the legislation. The problem with this type of approach is that whilst it is effective as an anti avoidance rule, it does require a person to consider each of the conditions mentioned above before they can be ruled out. This can create unnecessary compliance costs for businesses and individuals involved in wholly innocent TiS. 3.3 Proposed Change To address this problem and with a view to providing a clearer, simpler way of identifying whether TiS are within the scope of the TiS legislation, this proposal will amend the TiS legislation to put a new purpose test at the start of the legislation. For demonstration purposes this is shown as part of amendments to ITA 2007 (proposed new section 684), the parallel change for CT purposes would be incorporated in the proposed CTA 2010. The new test would be constructed as follows: (a) (b) (c) a person must be party to a TiS (or two or more TiS), The TiS falls within Condition A or B of the circumstance set out in the new section 684 (broadly what was covered previously in circumstances D and E which have been merged into section 684) the person is unable to take advantage of the Exclusion at section 685 (see the proposal 4 on the new fundamental change of ownership rule) and 9 Simplifying Transactions in Securities Legislation
(d) an income tax advantage is obtained by that person. This proposal includes a refined definition of tax advantage which incorporates a clear method for calculating that advantage. Section 683(d) makes it clear that where there is no income tax advantage obtained by a person, then the TiS legislation will not apply to them. In addition, for the first time, the proposed legislation, through the definition of tax advantage would make it clear that the TiS legislation does not apply to TiS where an advantage in relation to tax on chargeable gains is obtained. This would be more relevant for corporation tax where the position is not clear from the existing legislation. The proposed legislation would bring into scope only those transactions where obtaining a tax advantage was a main purpose, in contrast with current legislation where all transactions are potentially in scope. Genuine commercial transactions (i.e. those where gaining or obtaining a tax advantage was not a main purpose, or one of the main purposes) would effectively be removed from the legislation by the introduction of this refocused test, therefore increasing certainty and clarity for customers. The separate 'Escape Clause' would no longer be required and so this package includes a proposal to repeal section 685 ITA 2007. We are not proposing a widening of the legislation, the purpose of this new approach is to narrow its scope to include only those TiS which are undertaken with a main purpose of obtaining a tax advantage. The proposed draft legislation does not contain a provision that explicitly sets out the equivalent of section 684(3) ITA 2007. That covers situations where an income tax advantage is obtained or obtainable by a person in consequence of a TiS or the combined effect of two or more TiS, if it is in consequence of the combined effect of the transaction or transactions and a liquidation. We consider that the proposed legislation should be capable of covering this type of situation, without needing to deal with it separately. We would welcome your opinions on whether you consider the new draft legislation adequately covers the situations that were intended to fall within section 684(3). 3.4 Costs and Benefits This proposal is revenue neutral. It solely focuses on reducing the unnecessary administrative burdens incurred by customers considering the impact of the TiS legislation by focusing the legislation upfront only on wholly commercial transactions with no tax avoidance purpose. 3.5 Questions for consultation This is a fundamental change in approach to the way in which the TiS legislation will be applied. The emphasis will now be on transactions where gaining a tax advantage is a main (or one of the main purposes) of the transactions. The idea of a framework for purpose tests is the subject of a separate discussion document called "Simplifying Unallowable Purpose Tests". You may find it useful to consider the ideas in that document in conjunction with this consultation document. 3.5.1 Do you have any thoughts on this shift in focus within the TiS legislation? 3.5.2 Do you consider there are there any pitfalls you can see for customers? 3.5.3 Do you consider this will this help provide certainty and clarity for customers? 3.5.4 Do you consider this will lead to less work or more work for our customers? 10 Simplifying Transactions in Securities Legislation
4. Proposal 2: Adopt the definition of a close company for 'Relevant Company' in section 691 ITA 2007. 4.1 Aim of the Proposal The aim of this proposal is to simplify the definition of a "Relevant Company" by aligning this definition, with the more widely known and understood definition of "Close Company" in sections 414 and 415 ICTA 1988. This would achieve the following: (a) (b) (c) (d) It would provide users of the legislation with a clear, commonly understood, definition of what type of company the current Circumstances D and E of both the IT and CT legislation will apply to. It would clear any uncertainty as to whether the definition of Relevant Company is EU compliant. It has been suggested to HMRC that because the current definition includes a requirement that a company has to be listed in the UK and dealt in on a recognised stock exchange in the UK, not on any other equivalent stock exchanges within the EU, there may be concerns that it is not EU compliant and in need of amendment to ensure it is EU compliant. Adopting the Close Company definition should resolve this matter. It would close a current opportunity for avoidance which enables companies to fall out of the scope of the prescribed circumstance D currently found at section 704D ICTA 1988 and section 689 ITA 2007 by inserting listed companies in their group structure, a practice known as 'D proofing'. It would allow section 689 ITA 2007 Circumstance C to be repealed (see Proposal 3). We consider that those TiS that are currently caught by section 688 ITA 2007 would be caught by section 684 in the draft legislation where Condition A or B are met (currently section 689 and section 690 ITA 2007). We are still considering whether this proposal will allow a similar repeal of the CT equivalent in section 704C ICTA 1988. 4.2 Current Position Currently, the TiS legislation uses a unique definition of a Relevant Company, limiting the application of the legislation under certain circumstances, to companies falling under what is commonly termed the 'D2' definition. There are good reasons (mentioned above) for aligning the D2 company definition with the more commonly known definition of a Close Company. Given the potential avoidance risk and the possibility that the D2 company definition may not be EU compliant, it is likely that the current Relevant Company definition would have been subject to amendment in any case. However, a real benefit of doing this as part of this simplification review is that it delivers a further simplification of the TiS legislation with the proposed repeal of the C Circumstance in section 688 ITA 2007. 4.3 Proposed Change The proposal is to simplify the legislation by replacing the current definition of a relevant company in section 691 ITA 2007 so that it has the same meaning as close company in sections 414 and 415 ICTA 1988 for the purposes of ITA 2007. This new definition should: (a) (b) facilitate the repeal of section 688 ITA 2007, the C Circumstance. remove the avoidance risk known as D proofing with minimal impact to administrative burdens. This should be a simple and straightforward change that external consultations have suggested would be widely welcomed. 11 Simplifying Transactions in Securities Legislation
(c) the change would also ensure compliance with EU law, which we would otherwise need to address outside of the Anti-Avoidance Simplification Review. This change should mean that separate new anti-avoidance rules are not required to prevent this form of avoidance, as the new close company definition should effectively address the current avoidance risks. 4.4 Costs and Benefits This new definition should have minimum impact from a compliance cost perspective. As this proposal will close a loophole in the legislation (albeit used by a small number of customers) it is potentially both a revenue raising and a revenue protection measure. We estimate that this proposal will in 2010/11 protect revenue of 130 million and yield 30 million and that each subsequent year to 2013/14 this proposal will protect revenue of 50 million and raise an additional 15 million of revenue. Please refer to Annex G for the Impact Assessment on this measure specifically, and on the consultation document as a whole. 4.5 Questions for consultation 4.5.1 Do you consider this change will be beneficial for HMRC's customers? 4.5.2 Do you have any reservations about the change in close company definition? 4.5.3 Do you foresee any practical problems or benefits? 4.5.4 Can you foresee any issues with certain situations, such as Management Buy Outs (where more than 5 managers buy control of a company), which would be affected by the change of the close company definition? 12 Simplifying Transactions in Securities Legislation
5. Proposal 3: Simplifying the remaining circumstances in sections 686 to 690 ITA 2007. 5.1 Aim of the Proposal The aim of this proposal is to simplify the legislation by: (a) (b) (c) Repealing section 704A ICTA 1988 which is now largely obsolete apart from a very narrow application with regard to Shadow Advance Corporation Tax (Shadow ACT). We propose a much more targeted amendment to the Shadow ACT Regulations (SI 1999/358) will secure the required revenue protection in this area. Repealing section 686 ITA 2007 which sets out the equivalent circumstance A and is now considered redundant since the abolition of tax credits in 1999. Repealing section 688 ITA 2007 which sets out the circumstance C. A repeal of this provision for IT purposes is a follow-on from Proposal 2 (Adopt the definition of a close company for 'Relevant Company' in section 691 ITA 2007). Replacing the definition of a relevant company will mean that the type of arrangements we have seen in the past that would normally fall within the circumstance C would now fall within the circumstance D, consequently, there is no longer a need to retain the circumstance C for income tax purposes. We are still considering whether this proposal will allow a similar repeal of the CT equivalent in section 704C ICTA 1988 One consequence of repealing sections 686 and 688, will mean that there is no need to retain the following provisions in ITA 2007: sections 692, 693 and 694. These sections relate to the meaning of abnormal dividends for the purposes of sections 686 and 688 ITA 2007. Whether the equivalent sections for CT purposes can be repealed will depend on whether it is possible to repeal section 704C ICTA 1988. Together, these changes should further increase certainty and clarity for customers. 5.2 Current Position Section 686 ITA 2007 (Circumstance A) applies after 5 April 2007 for IT purposes where a person receives an abnormal amount by way of dividend and the receipt is in connection with (a) (b) (c) (d) the purchase of securities followed by the sale of securities a sale of securities followed by a purchase of securities the distribution, transfer or realisation of assets of a company, or the application of those assets in discharge of liabilities and the amount so received is taken into account for exemption from income tax, setting off of losses against profits or income or the giving of relief for certain interest payments Section 704A ICTA 1988 (Circumstance A) applies (for CT purposes, for accounting periods ending after 5 April 2007) where a person receives an abnormal amount by way of dividend and the receipt is in connection with (a) (b) a distribution of profits of a company or the sale or purchase of securities followed by the purchase or sale of securities and the amount so received is taken into account for any exemption from corporation tax, the setting off of losses against profits or income, the giving of group relief or the application of franked investment income in computing Shadow ACT. 13 Simplifying Transactions in Securities Legislation
For income and corporation tax in earlier periods (section 704 ICTA 1988), Circumstance A applies where a person receives an abnormal amount by way of dividend in connection with the distribution of profit of a company or the purchase or sale of securities followed by a sale or purchase of securities. The amount received must be taken into account for: any exemption from tax, setting off losses against profit or income, giving group relief, obtaining relief for certain interest payments, the application of franked investment income in computing Shadow ACT, or franking annual payments. Section 688 ITA 2007 (Circumstance C) applies where a person receives consideration which is or represents the value of (a) (b) (c) assets which are available for distribution by a company by way of dividend, or assets which would have been so available apart from anything done by the company, is received in respect of future receipts of a company, or is or represents the value of trading stock of a company, and the receipt is in consequence of a transaction whereby another person subsequently receives, or has received, an abnormal amount by way of dividend. The assets referred to above do not include those shown to represent a return of sums paid by subscribers on the issue of securities, despite the fact that, under the law of the country in which the company is incorporated, assets of that description are available for distribution by way of dividend. References to the receipt of consideration include references to the receipt of any money or money s worth. A dividend is considered abnormal for the circumstances A and C if the excessive return condition is met or in the case of a dividend at a fixed rate, if the excessive accrual condition is met. The conditions are set out in sections 692 to 694 ITA 2007 and section 709(4) ICTA 1988. 5.3 Proposed Change Corporation Tax We propose to repeal section 704A ICTA 1988 and, at the same time, amend the Shadow ACT regulations (SI 1999/358). Although the above refers to ICTA 1988, this is for demonstration purposes. The changes would actually be made to the proposed CTA 2010. Income Tax We propose to amend ITA 2007 as follows: (a) (b) (c) Repeal section 686 which contains the A circumstance. Repeal section 688 which contains the E circumstance. Repeal sections 692, 693 and 694 which deal with abnormal dividends and are only relevant to the A and C circumstances mentioned above. If the above sections are repealed, there would only be two remaining circumstances for IT purposes in ITA 2007, section 689 (Circumstance D) and section 690 (Circumstance E.) This proposal would amalgamate them into the new section 684. In broad terms, the new section 684 seeks to replicate and simplify the provisions in sections 689 and 690 ITA 2007. We welcome your views on whether the new section 684 achieves this and any feedback on whether and how the new section 684 should be amended in order to retain the features of the existing sections 689 and 690 whilst presenting them in a clearer and more easily understood fashion. When considering this proposal please bear in mind the proposed change in the definition of a company in section 691 ITA 2007 (Proposal 2). 14 Simplifying Transactions in Securities Legislation
5.4 Costs and Benefits This is a revenue neutral proposal. Amending the legislation in a clear, well targeted and effective manner should increase certainty and clarity regarding the scope and application of the TiS legislation and therefore reduce our customers' administrative burden. It should also result in fewer clearance applications being made to HMRC. 5.5 Questions for Consultation 5.5.1 Do you agree with the repeals of section 686 ITA 2007 and its CT counterpart? 5.5.2 Do you agree with the repeals of sections 688, 692, 693, 694 ITA 2007? 5.5.3 Do you agree that sections 689 and 690 ITA should be merged into one single circumstance? Or would you prefer to have these two provisions retained in their current form? 5.5.4 Do you have any views on the new section 684? 5.5.5 Do you have any views or suggestions on how to amend the new section 684 so that it can be made clearer and more easily understood by our customers? 15 Simplifying Transactions in Securities Legislation
6. Proposal 4: The fundamental change of ownership rule 6.1 Aim of the Proposal The aim of this proposal is to remove from the scope of the TiS legislation those TiS that result from a fundamental change in ownership. Such a rule should increase certainty in those cases where there has been a fundamental change in ownership, reducing the compliance costs and advisors' fees for our customers. The fundamental change of ownership exclusion is included at section 685 of the draft legislation. 6.2 Current Position At present, there is no statutory exclusion of any specific TiS from the scope of the legislation. Specifically, there is no 'fundamental change of ownership' exclusion. This means that many unnecessary clearance applications being made by customers in that, in such cases, the applications are approved as it is clear that the transactions are motivated by a commercial purpose rather than any tax avoidance motive. Accordingly, we are aware that customers involved with fundamental change in ownership transactions may be facing unnecessary compliance costs and advisors' fees. 6.3 Proposed Change The proposal is to introduce a new rule in section 685 to exclude from new section 684 a person who is party to a TiS of a close company if immediately before the TiS that person holds shares or an interest in that company and the TiS results in a fundamental change in ownership of that company. This will provide clarity by specifically removing these transactions from the scope of the legislation. We propose to define a fundamental change of ownership as being when each of the three conditions below is met for a period of two years from when all of these conditions are met. (a) (b) (c) at least 75% of the ordinary share capital of the company is held beneficially by a person (or persons) who is not, and never has been, connected with the person mentioned in section 683 (e.g. the person who is party to the TiS); the shares in the close company are held by the person or persons mentioned in (a) above carry an entitlement to at least 75% of the distributions which may be made by that company; the shares so held carry at least 75% of the total voting rights in the close company. Section 685 is designed only to exclude those cases which, in our view, would otherwise fall outside the scope of the TiS legislation. A person who fails these tests will be liable to counteraction of an income tax advantage only if the other technical provisions (e.g. the purpose test in section 683) of the TiS legislation are met. The period of two years is proposed as a reasonable length of time to ensure that the fundamental change in ownership is substantive, in other words, protecting against the situation where the conditions A to C mentioned above are met at the time of the TiS but afterwards there are further transactions or arrangements which return ownership of some or all of the shares/interest in the close company to the original shareholders. The proposed level of 75% is based on the current HMRC practice to grant clearance in most cases where there has been a 75% change in ownership. The new exclusion therefore removes from the legislation those TiS which would typically be granted rapid clearance. At this level, we expect to provide increased certainty and clarity, reducing the number of clearance applications without creating any additional avoidance opportunities. This exemption should not be available in situations where the vendors and purchasers are connected persons either before, during or after the change of ownership. Connected persons for these purposes would have the same meaning as section 993 ITA 2007. 16 Simplifying Transactions in Securities Legislation
We do not propose to remove or modify the statutory clearance procedures. 6.4 Costs and Benefits This should be a revenue neutral proposal, as the above proposals are closely based on current HMRC practice. 6.5 Questions for Consultation 6.5.1 Do you consider this change will benefit potential clearance applicants and their advisers? 6.5.2 Do you consider that the proposed test accurately describes what a fundamental change in ownership is? If not, what other factors should be considered? 6.5.3 Are you aware of any other indicators that can be used to separate genuine transactions from those implemented for avoidance purposes? 6.5.4 Do you consider 75% is an appropriate level for this proposal? If not, what level do you feel would be more appropriate and why? 17 Simplifying Transactions in Securities Legislation
7. Proposal 5: Defining and quantifying 'Tax Advantage' 7.1 Aim of the Proposal The aim of this proposal is to introduce a new statutory definition of 'income tax advantage' in the TiS legislation, based on current HMRC practice. The proposal would replace the existing meaning of income tax advantage in section 683 ITA 2007, with a more targeted definition to provide greater clarity to our customers, based around the calculation of the amount of the tax advantage that would be subject to counteraction. The proposal does not include the introduction of a lower limit for when counteraction will take place. This is because each case will continue to be treated individually on its own set of facts. Although this consultation document focuses on IT advantages, it is envisaged a similar approach would be replicated for CT purposes in CTA 2010. The new definition of income tax advantage is contained in section 686 of in the draft legislation in Annex C. We welcome your views on the benefits of quantifying the tax advantage in statute and whether the approach set out in the draft legislation under this proposal achieves those benefits. 7.2 Current Position The TiS legislation does not apply if no tax advantage is obtained or obtainable in consequence of the TiS. Though 'tax advantage' is currently defined in legislation at section 683 ITA 2007 and section 709 ICTA 1988 they are very wide definitions and this has led to uncertainty. During previous more informal consultations, we received repeated requests to be clearer on how we define and quantify the tax advantage when applying the legislation. Neither the current legislation nor the new proposal set any lower limit for when counteraction will be taken. 7.3 Proposed Change We propose a more targeted approach to establish the amount of the 'income tax advantage' obtained, by comparing the tax due on proceeds received as capital with the amount of income tax that would have been due had the amount available for distribution been received as income. Put simply, the amount subject to counteraction would be the difference between the two amounts. 7.4 Section 686 of the draft legislation: "Income Tax Advantage" The proposed draft legislation at section 686 defines an income tax advantage by taking the amount of IT payable by a person receiving relevant consideration (which in most cases will be the amount of proceeds received by a person from a sale of shares or securities) had that consideration been received as an income dividend, and comparing this with the amount of capital gains tax actually payable (after all capital gains tax reliefs and exemptions). The proposal regards any difference between the hypothetical income tax and actual capital gains tax payable as the tax advantage which is the subject of counteraction. This will mean that section 699 ITA 2007 which limits the amount assessed in sections 689 and 690 (D and E circumstance) could be repealed as the proposed new section 686 sets out the amount of the income tax advantage to be counteracted. New section 686(1)(b) takes into account situations where there is no actual capital gains tax payable. 18 Simplifying Transactions in Securities Legislation
Calculation of income tax advantage The following sets out a simple example to illustrate these new rules. All figures in the example below are hypothetical and serve merely to illustrate the proposed logic for calculating the 'tax advantage'. Step 1 Calculation of amounts not subject to counteraction Proceeds received as capital from a company (e.g. relevant consideration) 100 A Amount that would have been available for distribution (say) 90 B The amount not subject to counteraction is (A-B) 10 C B is therefore the amount potentially subject to counteraction. Step 2 Compare the tax due on (B) as if it was an income dividend Amount potentially subject to counteraction 90 B Tax paid on B say 18% CGT rate (ignoring reliefs/exemptions) 16 D Tax payable if B constituted a qualifying distribution (a dividend) 22 E (e.g. 25% of net dividend for person paying tax in the 40% bracket after taking into account notional tax credits) Step 3 Income Tax advantage per section 686 IT that would have been payable less the actual tax paid (E-D) 6 It is this additional tax due that would be subject to counteraction if the customer cannot avail themselves of any of the exclusions such as section 685, the fundamental change of ownership proposal. The Income Tax advantage arises when the person receives the relevant consideration. 7.5 Costs and Benefits Formalising the quantification of the tax advantage would be revenue neutral, as the above formula is closely based on current HMRC practice. There are clear benefits in terms of clarity and consistency for our customers if a method for quantifying the tax advantage is introduced. It will also help clarify the tax avoidance that the TiS legislation is designed to target. 7.6 Questions for consultation 7.6.1 Do you consider there are benefits to quantifying the 'tax advantage' in statute in the way set out in the new section 683 ITA 2007? 7.6.2 Do you agree with the principle and approach detailed above? 7.6.3 Do you consider it would be appropriate to include any conditions or restrictions? If so where and why? 7.6.4 Do you have any other comments or concerns with this proposal? If so, what are they? 19 Simplifying Transactions in Securities Legislation
8. Proposal 6: Clarifying the scope of the Transaction in Securities legislation 8.1 Aim of the Proposal HMRC have received feedback from customers that suggests they would like clarity on whether the TiS legislation applies to situations where capital gains are converted into income. For income tax purposes the proposed changes in Proposal 5 'Defining and Quantifying the Tax Advantage' relating to the draft legislation at section 686 will provide sufficient certainty on this matter. No further amendments to the legislation will be required as section 686 describes the comparator that needs to be considered and it does not include a reduction in the level of capital gains tax that is paid. Although this consultation document focuses on the changes to ITA 2007, it is envisaged a similar approach would be replicated for CT purposes in CTA 2010. 8.2 Current Position This issue does not currently affect the provisions in ITA 2007, as the issue is more of a concern for our customers in relation to corporation tax. Whilst HMRC has not taken up any cases involving a company s chargeable gains, the legislation could in theory apply to avoidance of corporation tax on chargeable gains. This is because the definition of tax advantage at section 709(1) ICTA 1988 does not specify whether or not 'tax advantage' for a company includes the avoidance of corporation tax on chargeable gains. 8.3 Proposed Change We propose to make clear in the new guidance on the TiS Legislation (mentioned in proposal 7) that the TiS legislation only applies where the tax advantage relates to corporation tax on a company's income and not to its chargeable gains. This Consultation only covers how we propose to clarify the scope of the TiS legislation for IT purposes by narrowing the definition of "income tax advantage". It is envisaged that a similar approach will be adopted for CT to make clear in the statute that for the purposes of the TiS legislation a corporation tax advantage excludes tax advantages relating to a company's chargeable gains. 8.4 Costs and Benefits This proposal should be revenue neutral as it is based on current HMRC practice. It should also reduce administrative burdens for HMRC and our customers because it will provide increased certainty regarding when a clearance application is required. 8.5 Questions for consultation 8.5.1 Do you have any concerns with this proposal? 20 Simplifying Transactions in Securities Legislation
9. Proposal 7: Framework guidance for Transactions in Securities 9.1 Aim of the Proposal There is currently only limited HMRC guidance on the practical application of sections 703 to 709 ICTA 1988 and sections 682 to 713 ITA 2007 at CTM36805 to CTM36885. This proposal is to publish clear and more extensive guidance for the new simplified TiS legislation. This should improve understanding of the legislation and reduce customers' uncertainty and compliance costs 9.2 Current Position Broadly, the current guidance covers the clearance and counteraction process and the type of transactions that might be caught by the prescribed circumstances in sections 704A-E ICTA 1988. The guidance does not draw on any case law or provide practical examples of when the legislation takes effect, which we understand has led to uncertainty for customers. This has resulted in a number of arguably unnecessary clearance applications and significant demand from customers and advisors for more guidance on the TiS legislation. 9.3 Proposed Change We propose to publish detailed guidance which meets our customers' requirements for certainty and clarity. It is intended that any guidance will cover sections 682 to 713 ITA 2007 (for IT purposes) as amended by the proposals contained in this consultation document and the equivalent or similar provisions for CT that will be contained in the CTA 2010. The guidance will set out the position from the date that the simplified TiS legislation comes into effect. Annex D of this document contains (for illustrative purposes only) an overview of the contents, format and level of detail that will form the basis of the full guidance. It will cover all areas of the amended legislation and will include practical examples where appropriate. Annex D only refers to guidance covering the TiS legislation for IT purposes contained in ITA 2007. It is envisaged that similar guidance will be produced covering CT aspects of the TiS legislation that will be rewritten for CTA 2010 either as a standalone document or if practical (and the preferred approach) incorporated into one document covering the TiS legislation for both IT and CT purposes. Overview The new guidance will include a brief introduction to the history and purpose of the legislation and provide an overview of how the TiS legislation is intended to work. Technical The guidance will include sections covering HMRC's interpretation of key technical phrases contained in the legislation such as the meaning of income tax advantage together with an explanation of the method of quantifying any income tax advantage that arises. Circumstance This part will include guidance on the prescribed circumstances as amended by the draft legislation at section 684 although this will still be very much based around the existing circumstance D and E. 21 Simplifying Transactions in Securities Legislation
The purpose test This part will include guidance on how to interpret and apply the new purpose test found section 683. Procedural Matters This part will include explanation of the clearance and counteraction process detailing the procedures of how to obtain clearance for a specific transaction, what should go into a clearance application and what to do if you do not agree with the decision reached by HMRC. There will also be a section on the counteraction process and new appeals process. Specific Areas of Difficulty There will be sections in the guidance that cover specific areas that are currently causing problems to our customers, using practical examples to demonstrate how the principles and legislation should be applied. It is envisaged that this section of the guidance may over time grow to include more areas of difficulties as they arise and your opinion of areas that should be covered is welcomed. 9.4 Costs and Benefits This is a revenue neutral proposal. If the guidance fulfils the stated aims it should provide the desired certainty and clarity and decrease compliance costs for customers, their advisors and HMRC. It should also help to provide businesses, advisors and representative bodies with a better understanding of the TiS legislation and its practical application. By addressing specific sets of customer circumstances, we also anticipate that comprehensive guidance will result in a decrease in the number of clearance applications. 9.5 Questions for consultation 9.5.1 Would better guidance increase certainty and reduce administrative burdens? 9.5.2 Would better guidance reduce your need to submit clearance applications to HMRC? 9.5.3 Are there any other areas or subjects you would like to see included in the guidance? 9.5.4 Does our proposed layout meet customers' needs (i.e. is it appropriate and comprehensive)? If not, what changes would you suggest to the proposed layout and content? 9.5.5 If the proposed layout is adopted, what specific case law guidance would you like included under 'Specific Areas of Difficulty'? 22 Simplifying Transactions in Securities Legislation