Is it tax advice? Is it a tax solution? No, it’s a tax scheme!
We consider how the tests applied in recent cases will be considered when and if HMRC scrutinise tax planning. The way the tax tribunal and courts view tax planning inherently affects how officers of HMRC perceive transactions.
On 27th March the news story “HMRC scores a hat-trick of avoidance” was released regarding three First Tier Tribunal cases:
Steve Price, John Myers and James Lucas v HMRC
Malcolm Healey v HMRC
Philip Savva, Andrew Savva, Mario Savva, Savva Savva and Kalliopi Pericleous v HMRC
The headline, which could have been written by a tabloid newspaper, demonstrates HMRC’s pride at winning against NT Advisers (now nine times). Armed with significant recent success at the courts any enthusiastic HMRC officer may feel exceptionally confident that their view of what constitutes a tax scheme is correct.
Turning to the case of Steve Price, John Myers and James Lucas, the tax scheme which was implemented in 2005/06 involved:
the acquisition of options to acquire shares
the exercise of those options and payment
the sale of the shares
The intended result was that the sale of those shares provided a capital loss which could be translated into an income loss under section 574 TA 1988 so as to be available against other income. The tax scheme was operated for ten to twenty clients at any one time and repeated in several waves amounting to some 420 users.
Mr. Myers was one of the participants in Round 1 whilst Mr Price and Mr Lucas were in Round 2. The losses intended to be created amounted to £6m for Myers and £0.3m for Price and Lucas. The anticipated tax protected through the three wins is estimated at £260m.
The Round 1 tax scheme broadly included the following steps:
Mr. Myers was assigned an option to acquire shares in Stony Heating Ltd (SHL)
The option was exercised and £6m paid
SHL issued the shares to Myers
A few days later Myers sold the shares for £552
The premise was that the options provisions in sections 144 to 144ZD TCGA applied and that for Capital Gains Tax (CGT) purposes his allowable expenditure available for deduction in computing his gain or loss on the disposal of the SHL shares (his “CGT base cost”) was £6 million. If that were correct, Myers would have made a capital loss of just under £6 million on their sale. SHL would have been a qualifying trading company and section 574 treats the capital loss into an income loss available for offset against other taxable income.
The same steps were followed in relation to Round 2 all be it with a minor adjustment: On the same day as the shares were acquired in SHL they were made the subject of a deed poll executed by SHL which it is said made them “convertible securities” and potentially subject to the regime in section 149AA TCGA. The application of section 149AA is said to have the effect that the CGT base cost of the shares was the amount paid for them.
After the above steps each participant owed his subscription price for the SHL shares to a discretionary trust of which he was the principal beneficiary, and whose assets consisted mainly of that debt.
The end result of the planning was:
An amount to offset against income thereby reducing a tax liability
Being the beneficiary of a trust which the user owed the subscription funds to thereby resulting in no significant economic difference for the user i.e. a loss for tax purposes and no economic loss
The planning was structured with the help of:
A series of loans and share redemptions and subscriptions in which monies moved from Hambros Bank through the participating entities and back to Hambros.
Stony Heating and Bathroom Supplies Limited, a company which became a subsidiary of SHL, and whose activity was the business of a plumbing shop in the Milton Keynes area! The director was a Mr Forster.
Mark Jenner who is the brother of Matthew Jenner of NT Advisors Ltd was an apprentice plumber and bought supplies from a shop ran by Mr Forster. Mr. Forster and Mark Jenner incorporated a joint venture Stony Heating and Bathroom Supplies Ltd in 2002. The venture did not prosper and by the end of 2005 it was virtually dormant. Mark Jenner remained a director although Mr Forster ceased to be a director on 30 April 2007.
Mark’s brother, Matthew ran a tax advisory business, NT Advisors Ltd, with Mr. Anthony Mehigan. Matthew became responsible for discussing the concept of the tax scheme with SG Hambros and seeking Queen’s Counsel’s opinion (Rex Bretten QC). Given the requirement for the acquisition of shares in a “qualifying company” and the requirement that options be acquired by reason of a person’s employment, enter Stony Heating and Bathroom Supplies Ltd and Mark Jenner.
Whilst we would love to analyse the case in detail it runs to some 39 pages and we feel that the reader may not last the distance. In summary these are the pertinent questions raised:
Were the transactions an artificial scheme to create an allowable loss?
Was the exercise of the options non-commercial?
Was there a securities option?
Was the deed poll an arrangement for conversion of shares?
Were there employment related securities?
Was the option acquired by reason of the employment of another person?
Was there a qualifying trading company?
Was the sale of shares at arm’s length?
The discussions of the tribunal focused on the detailed provision of the legislation although the recurring concepts of the review considered the following:
The intended effect or nature of each particular concept used by the statute
Whether the transaction realistically fitted into the intended effect/concept of the statute
Whether each party acted with a mind to their own interests
How each party acted in the scheme, whether as a whole and or in its part or his own part
Whether transactions were commercial as a whole or in its own part
This is not a new method of looking at schematic planning although the question is whether the approach should be applied to all tax planning and whether that planning would stand up to scrutiny.
For example, let us consider an arrangement whereby a company enters into arrangements to reduce its profits for tax purposes and by virtue of those or further arrangements, a shareholder or employee receives a loan from a trust they are a beneficiary of. Let us suppose that the arrangement is with an unconnected third party who through their own mind, chooses to place funds within a trust or make a loan.
It would appear that the tribunal would view the arrangements giving regard to what the purpose of each party was intending to achieve at the outset: If that was the avoidance of tax, they may adopt a position to find a way in which to set the arrangements aside. It therefore appears to be more important than ever to establish the reasons (those other than avoiding tax) for transactions and determine the factor which more strongly influenced the reason. For ease of understanding:
Was the motive to give assets away in a prescribed manner or avoid Inheritance Tax (IHT)? Obviously it will depend on the circumstances, although a gift on the deathbed which reduces the estate immediately may be viewed differently as opposed to the investment into business property, which is then place in trust two years later.
A contract with a service provider who pays you a low amount for providing your services but you have the opportunity to benefit from a trust because there are commercial benefits (marketability, knowledge sharing etc.) or to avoid income tax? Where the commercial benefits are limited, arrangements are likely to be scrutinised. It is envisaged that quite simply commerciality will be a test of the reasons why an individual would give up an ability to have an income stream by entering into an arrangement where economically they still benefit from that income stream.
Invest into a vehicle that provides tax relief. The relief may be created by the costs incurred by the investment vehicle ahead of doing something to create revenue. Are those costs incurred for commercial reasons in a commercial manner reasonably expected and intended by the legislation? What if costs include commissions to introducers or by virtue of finance arrangements (which could be circular when considering the whole) allowing much higher expenditure, would it still be commercial?
In summary, a good deal of historic planning will be the subject of challenge over time applying the approach adopted by the courts. Some current planning may also suffer from the same risks.
We can assist to:
Identify the potential risks
Assess the likelihood of scrutiny by HMRC
Preempt risks and propose ways to manage them
Ascertain whether a transaction (or series of) will be successful