A special commissioner decided that a sale of shares was carried out for bona fide commercial reasons, but with the main object of enabling a tax advantage to be obtained. Accordingly, the Revenue were entitled to issue a notice cancelling the tax advantage.

Facts

In December 2002, the taxpayer sold his 38.2 per cent shareholding in P Ltd to PH Ltd for £275,000 paid in cash. PH Ltd held 47 per cent of the shares in P Ltd prior to the transaction. There were two minority shareholders (C and J) in P Ltd. The taxpayer held in excess of 50 per cent of the issued share capital of PH Ltd and was able to exercise control over both companies.

The taxpayer was 50 when the transaction took place. He received retirement relief of £125,000. (Retirement relief for CGT was withdrawn at the start of the 2003–04 tax year.)

In receiving consideration for the transaction in the form he did, the taxpayer paid CGT of £6,392.40. Had he received his consideration in the form of income, an extra £62,357.60 in income tax would have become due for the tax year ending April 2003, in addition to the amount already paid by the taxpayer.

The taxpayer appealed against a notice under ICTA 1988, s. 703(3) issued on the basis that he had obtained a tax advantage under s. 704 following a transaction in securities in the form of the sale by the taxpayer of his shares in the company. It was common ground that the conditions for the application of s. 704 circumstance D were satisfied and that there was a tax advantage. However, an issue arose whether the escape clause at the end of s. 703(1) applied.

The taxpayer's case was that he had agreed with C and J in principle that by the start of 2005 the shares in P Ltd would be held as to one-third each and that the transaction was intended to demonstrate to C and J that he was doing something to achieve the ultimate goal of equality of shareholdings.

The Revenue contended that the transaction did not advance C and J's position. The transaction was unnecessary to achieve the equality of shareholding envisaged for 2005 and the reason for it (and the only object of it) was to obtain the tax advantage.

Issue

Whether the transaction was carried out for bona fide commercial reasons; and whether its main object (or one of its main objects) was to enable the tax advantage to be obtained.

Decision

The special commissioner (Dr John Avery Jones) (dismissing the appeal) said that commercial reasons were subjective reasons why the transaction was carried out; the object (equated with purpose) was what the transaction hoped to achieve. In deciding whether the transaction was carried out for bona fide commercial reasons, it had to be looked at in the context of all the circumstances which gave rise to it, and not in isolation (Clark v IR Commrs (1978) 52 TC 482 considered).

In terms of logic, the transaction was unnecessary to achieve the ultimate goal of equality of shareholdings by 2005. The other shareholders were in the same position before and after it (except that P Ltd's funds were reduced by the dividend of £312,500 that was paid only on the preferred ordinary shares owned by PH Ltd, £275,000 of which went to the taxpayer as the purchase price of his shares, with a consequent diminution in value of their shares). If the transaction had not taken place, P Ltd could just as well have purchased both the taxpayer's and PH Ltd's ordinary shares in P Ltd.

Although the taxpayer believed that he decided on the transaction and that it was part of the arrangements for the ultimate equality of shareholdings, it was more likely that the transaction was a joint effort with the auditor who saw the tax benefits of the transaction and the taxpayer who saw some commercial benefit in putting his shareholding in P Ltd into PH Ltd as a first step to the goal of equal shareholdings, if only to show that he was doing something to achieve the ultimate end. It was not important who thought of it first. The other shareholders had had the transaction presented to them as one stage of achieving the ultimate end and they were unlikely to have queried whether the transaction was a necessary step. The transaction had the advantage that the other directors saw that something was being done towards the ultimate end. Retaining their services was important to P Ltd's business and was a commercial reason. The fact that it seemed that the transaction was unnecessary did not mean that the taxpayer did not believe that it was, or that the directors did not regard it as a step showing that the ultimate end was being pursued. Accordingly the transaction was carried out for bona fide commercial reasons.

On the second issue, whether at least one of the main objects was to enable tax advantages to be obtained, the tax advantage here was that P Ltd funded PH Ltd's purchase of the taxpayer's shares in P Ltd for £275,000 out of a dividend of £312,500 which, if it had been paid to the taxpayer, would have borne income tax but as a sale of his shares suffered only very limited capital gains tax of £6,392.40 because of retirement relief. While the taxpayer might not have been particularly concerned with tax, the auditor must have been and it was apparent from a meeting in August 2002 that the fact that the then current tax year was the last opportunity of obtaining retirement relief had been explained to the taxpayer. The taxpayer had commercial reasons for carrying out the transaction and therefore that was one of his main objects in carrying it out. The tax treatment of the transaction was important to the existence and timing of the transaction. If the only object was for PH Ltd to acquire the taxpayer's shares there could have been a share-for-share exchange. The tax advantage could not be said to be an effect rather than an object of the transaction. The tax advantage was one of the main objects of the transaction.

(2008) Sp C 672.
Decision released 11 March 2008.