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Busy Practitioner by Mark McLaughlin CTA (Fellow) ATT TEP

Mark McLaughlin CTA (Fellow) ATT TEP, General Editor of TaxationWeb, highlights anti-avoidance tests in connection with ‘share for share’ exchanges.Share transactions invariably have tax consequences, which often influence the structure of share deals. Tax relief provisions and anti-avoidance rules therefore need to be considered in advance. HMRC will not normally comment on tax planning (e.g. whether a certain tax relief applies in a particular situation). However, they do operate an advance clearance procedure in respect of certain anti-avoidance rules. One such rule is contained in TCGA 1992, s 137(1), which is intended to prevent the abuse of two forms of capital gains tax relief, one of which is the ‘share for share’ exchange relief in section 135.

The ‘tests’

Section 137(1) denies the ‘stand in shoes’ effect of the share exchange rules in section 135 if the share deal does not pass the following two separate and distinct tests, both of which must be satisfied before relief is available.

(a) the exchange must be for bona fide commercial reasons; and

(b) it must not form part of a scheme or arrangements which include a tax avoidance purpose (i.e. capital gains tax or corporation tax).

These tests were recently considered in Snell v HMRC Comrs (2006) SpC 532. In that case, the taxpayer sold his shares in a company in exchange for loan notes. He then emigrated before 5 April in that tax year, and redeemed the loan notes in the following tax year. The taxpayer was seeking to rely on TCGA 1992, s 135, under which the gain on the shares would have been deferred until the loan notes were repaid, by which time he would have been not resident (or ordinarily resident) in the UK and outside the scope of capital gains tax on the deferred gain. However, HMRC determined that section 137(1) applied to prevent share for share exchange relief. The taxpayer’s appeal against this determination was dismissed.

The Special Commissioners considered that the correct approach in test (a) above was to ask whether the sale of shares for loan notes was effected for bona fide commercial reasons, and held that this was the case. It was not necessary to compare the transaction with a share sale for cash, although it was recognised that the taxpayer wanted loan stock for tax reasons, and would not have agreed to a cash sale.

However, with regard to test (b) above, the Special Commissioners considered that Parliament had intended section 135 to allow a taxpayer to defer paying tax until he received cash, not to create an exemption from tax. If one of the taxpayer’s main purposes of the arrangements was to escape capital gains tax by redeeming the loan notes whilst non-resident, that was avoidance within section 137. The Commissioners held that the taxpayer intended, on the balance of probabilities, to become non-resident for the purpose of redeeming loan stock on an eventual share sale.

Advance clearance

Practitioners can obtain certainty for client share transactions involving relief under section 135, by applying for advance clearance (under section 138(1)) that HMRC are satisfied that the share exchange is for bona fide commercial reasons and does not form part of a scheme or arrangements with a tax avoidance motive. Clearance applications can also be made in respect of certain other provisions, including the ‘transactions in securities’ income tax anti-avoidance rule in TA 1988, s 703 (s 707). A single clearance application can be made in respect of TCGA 1992, s 135 and TA 1988, s 703. However, it should be remembered that those clearances only confirm that the above ‘tests’ are satisfied and not, for example, whether the ‘share for share’ conditions in TCGA 1992, s 135 are also met. In addition, all relevant transactions and information must be fully disclosed for the clearances to be relied upon. Further details on ‘Clearances and Approvals provided for in the Taxes Acts’ including addresses to submit clearance applications can be accessed via the HMRC website: http://www.hmrc.gov.uk/cap/index.htm#99