This month’s Chartered Accountants Tax Case Digest looks at the decision of the Court of Appeal in relation to a 2004 tax planning scheme to enable the Development Securities Group (“the Group”) take advantage of indexation relief on assets carrying latent losses, which would not have applied had the group disposed of the assets at their market value. The central issue of the case relates to the tax residency position of three special purpose vehicles and touches on the who, why and where of strategic and management decisions in determining where a company is centrally managed and controlled, and ultimately tax resident.

Background

The Group owned a number of subsidiaries (“the L&R Companies”) and properties whose market value were less than their acquisition cost. In an effort to maximise the losses for offset against gains elsewhere within the Group, three Jersey companies incorporated as subsidiaries of Development Securities Plc were granted call options to buy the L&R Companies and properties where certain conditions were satisfied. The options were exercised at a price equivalent to the asset’s base cost, plus indexation accrued, for capital gains purposes, being a price greater than their market value. Thereafter, steps were taken to crystalise the losses, with the losses being calculated by reference to the amounts paid by the Jersey companies. An election made under s179A of the Taxation of Chargeable Gains Act 1992 treated the losses as accruing to Development Securities Plc.

The tax planning scheme was considered only to be effective if the Jersey companies were resident in Jersey when they exercised the call options. UK resident directors replaced the Jersey resident directors following the exercise of the options, so the companies would be UK resident for tax purposes.

The FTT decision

The FTT, having considered the law on corporate residence, found that the Jersey board exercised the options on instruction “without any engagement with the substantive discussion” other than to confirm the transactions could be lawfully carried out, and merely served to rubber stamp the decisions of the parent company, which included confirmation that the transactions were for the parent company’s benefit. The Jersey incorporated companies were found not to be tax resident in Jersey, as the central management and control of the company vested in the parent company in London.

The UT’s decision

The UT considered the primary reason of the FTT’s decision to be founded on the directors entering into an “uncommercial transaction” when exercising the options and that there was a fundamental misunderstanding of:

1. the nature of the transactions entered into by the Jersey companies, and
2. the duties of the Jersey directors in relation to those transactions.

The UT found that the FTT was wrong in its findings that the Jersey directors were in breach of their duties having entered into a transaction at an over-value.

The Court of Appeal’s decision

The Court of Appeal ruled the UT’s view of the FTT decision to be incorrect, and the actions of the directors to enter an uncommercial transaction was not the primary reason for its decision. Its reasoning was said to be based on the fact that the engagement of the Jersey directors was in affect an agreement to implement the parent company’s decision, subject to confirming the lawfulness of the transaction. The decision of the FTT was noted as distinguishing the transactions as being uncommercial for the Jersey companies, not that they were “improper or inadvisable”.

The Court of Appeal considered the UT to have mischaracterised the decision of the FTT. The FTT’s conclusions were considered to be based in an understanding of the nature of the transactions and not to rest on a fundamental misunderstanding of the duties of the Jersey directors.

Lord Justice Nugee expressed his “considerable reservations” about the FTT’s reasoning. As these reservations would not make a difference to the result, they were set aside. He considered that to establish where the central management and control of the companies lay, it was not at issue as to why the directors made the decision they did or the amount of thought given to it, but whether they did in fact make it. The action of the Jersey directors on the instruction of the parent company was the “why” of their decision-making process. He therefore considered the strategic decision to acquire the assets at an overvalue to be the decision of the parent company.

Lord Justice David Richards added the relevant question for tax purposes to be “by whom and where was the decision taken”.

Conclusion

The UT’s criticisms of the FTT’s decision were considered not to be “well-founded” by the Court of Appeal. The central management and control of the Jersey companies was found to lie in London on the date the options were exercised.

The Court of Appeal in restoring the decision of the FTT brought into question the reasoning of its decision. Given the varying opinions, what amounts to definitive evidence capable of demonstrating “active engagement” of non-resident directors in determining the central management and control of a company is still at question, particularly for special purpose vehicles seeking to achieve a tax benefit.

The full judgment in this case is available at:- https://www.bailii.org/ew/cases/EWCA/Civ/2020/1705.html