Reasonable to avoid s 455, but is it an unreasonable charge?

Since its establishment under FA 2013, the GAAR Advisory Panel has issued nearly two dozen opinions. Until recently, it had upheld in every case the view that the undertaking of the arrangements referred to them was not a reasonable course of action.

The first case in which the Panel sided with the taxpayer and opined that the entering into and carrying out of the arrangements was a reasonable course of action is one involving the repayment of a loan made by a close company to a participator having the intended effect of avoiding the charge to tax under CTA 2010 s 455 that would otherwise arise.

The facts in the case are refreshingly simple.

On the last day of its accounting period ended on 31 May 2016 a close company (‘HoldCo’) was owed almost £10m by its majority shareholder (‘Owner’). Unless the loan was repaid before 28 February 2017, HoldCo would be obliged to account for tax under s 455. However, if the loan were to be repaid before then, the charge would be expunged by relief under s 458.

In February 2017, Owner duly repaid the debt he owed to HoldCo. What HMRC found objectionable was that he did so with money that he had borrowed from SubCo, a wholly-owned subsidiary of HoldCo.

There were subsequently other transactions (of which more, later). But it’s important to note the precise terms of HMRC’s GAAR notice. This identified the abusive tax arrangements as:

• the making of loans by Holdco to Owner, during the accounting period ended 31 May 2016;
• the making of loans to Owner by Subco on 20 February 2017 and 22 February 2017; and
• the use by Owner of the amounts loaned to him by Subco to fund the repayment of the loans from Holdco within nine months of the end of the accounting period in which they were made.

The GAAR Panel therefore considered only the transactions up to February 2017 and applied the GAAR principles to those transactions. This required consideration of a number of factors:

• Did the arrangements involve ‘contrived or abnormal steps’? The Panel thought not. It noted that Subco had substantial assets of its own (implying that the answer might have been different if Subco had had to borrow in order to make the loans); and it was not contrived or abnormal for it to make the loans. The fact that Owner used the money borrowed from Subco to repay debt due to Holdco did not vitiate that.
• Were the arrangements consistent with the principles and policy objectives of Part 10 Chapter 3? Noting that the legislative intent was to impose a tax charge on balances advanced to participators, the Panel was satisfied that the arrangements did indeed set out to defeat the policy objectives.
• Was there a shortcoming in the relevant legislation? The Panel noted that the legislation addressed the position of a company rather than a group. HMRC submitted that the legislation ‘was not drafted with [the sort of arrangements before the Panel] in mind. Had they been considered, it is likely the legislation would have made provision addressing them’. The taxpayer, however, thought it unlikely that groups had been simply overlooked: ‘it would be very unusual for legislation that obviously deals with questions of tax on corporates for the question of group treatment not to be considered by Parliament’. The Panel effectively concurred with the taxpayer: ‘Not covering group loans does seem a big and obvious matter and it does not seem to us that the GAAR can be used to cover such a gap’.
• Was there (paraphrasing s 207(4)) an elimination of a tax charge? The Panel was influenced by the fact that there had been no permanent extraction of money from Holdco (or SubCo) and that although the tax charge on the loan from HoldCo had been eliminated, it was replaced by a charge on the loan from SubCo.

Having regard to all the relevant factors (and recognising that there were aspects which would ‘fall to be held as subject to the GAAR provisions’), the Panel concluded that the arrangements could not be said not to be a reasonable course of action.

Lucky escape?

It’s important to note that the Panel was considering only events occurring up to February 2017. It expressly didn’t have regard to subsequent transactions, holding there was no evidence of the events it was considering and those subsequent transactions being ‘planned together and potentially being in effect a single arrangement’.

Thus, the Panel didn’t take account of the fact that the debt owed by Owner to Subco (which had grown to £24m by the end of Subco’s accounting year on 31 May 2017) was in turn repaid by Owner within nine months of the year-end (thus, again, avoiding a charge under s 455) with the proceeds of a fresh loan that Owner had obtained – from Holdco. And that Holdco was apparently able to extend that fresh loan to Owner only because it had in turn borrowed – from Subco!

It is difficult not to have some sympathy with the grinding of teeth that this must have occasioned at HMRC, especially when the Panel’s opinion quotes contemporary emails of the finance team at Holdco as referring to a need to ‘start cycling the [Subco] loan to [Owner] into [Holdco]’ and that ‘the money will be sent to [Holdco], to be sent to [Owner], to be sent back to [Subco] to clear the director’s loan’. The mystery is, perhaps, why the GAAR notice was issued in respect of the arrangements for repayment of the Holdco loan in 2017 rather than those for repayment of the Subco loan a year later, which on the face of it would have seemed much more fertile ground for an HMRC challenge.

Double tax

It’s notable that HMRC’s GAAR notice did not state the amount of tax that it considered should be charged by a counteraction notice; nor by whom it should be paid. At first blush one might think the answer is obvious: the amount of s 455 tax that would have been payable by Holdco if the Holdco loan had not been ‘artificially’ repaid. But wait: what about the loan made by SubCo? That was a real loan which gave rise to its own s 455 liability, which SubCo would have no choice but to self-assess. Would that not have been effective double taxation? If so, how, if at all, would it have been avoided?

And what about repayment of tax under s 458? Plainly, the trigger for that could no longer be the repayment of the Holdco loan, for that had already been repaid: so how could Holdco ever make a valid s 458 claim at all?

Why s 455?

We finish by exploring why s 455 and the associated legislation is there at all, what purported mischief it seeks to counter and why (in the writer’s view) it is a legislative misstep that is long overdue for repeal.

Very broadly, if an employee receives a benefit by reason of the employment, the benefit is charged to tax as if it were employment income. Of course, some benefits are exempt; and where a benefit is not exempt the measure of the benefit and of the tax charge may depend on the nature of the benefit. In principle, however, there is a charge to tax, the amount charged is intended to bear some resemblance to the value of the benefit and the charge falls where it naturally should – on the individual receiving the benefit.

Similarly, if a participator in a close company who is not an employee of it receives a benefit from the company, the benefit is charged to tax: in this case charged, as one would expect, as if it were dividend income. Again, the amount charged to tax may depend on the nature of the benefit and, again, the tax charge lies on the participator.

If I am both employee and participator I do not, of course, get charged twice on the same benefit.

Thus, the basis on which tax law applies to most benefits provided by an employer to an employee or by a company to a participator is a rational and coherent one: the value of the benefit is taxed (once!) on the recipient and that is that. Unless, that is, the benefit consists in the provision of financial accommodation (broadly, a loan).

If I happen to be a participator in the company, a curious tax charge arises, at a rate of 33.75% of the amount of the loan – and this is in addition to any tax charge that might arise on me personally as an employee or director.

The first curious thing about the additional tax charge is that it is imposed not on me, as the recipient of the benefit, but on the company, as the provider of it.

The second is that although there are any number of classes of asset that my company may put at my disposal, there is only one class of asset – essentially, money – that attracts this tax charge. If my company buys a house for £1m and lends it to me free of charge: no s 455 tax. But if my company lends me £1m wherewith to buy myself a house: s 455 tax of £337,500.

The third is that the charge to tax under s 455 is computed not by reference to the size of the benefit (which is determined by rates of interest from time) but by reference to the size of the loan.

Tax charged under s 455 is, of course, repaid following repayment (or release) of the indebtedness which gave rise to it. But that does nothing to repair the illogicality of imposing it in the first place.

The usual justification is along the lines that it prevents company owners from securing an ‘unfair tax advantage’ by taking loans in place of dividend or remuneration. But that hardly stacks up as a justification: using the company’s money is no more securing ‘an unfair tax advantage’ than using any other asset of the company. In taking a loan, the owner is certainly securing a benefit, but it is a different and smaller economic benefit than a dividend or remuneration would afford. Unquestionably, the full measure of that benefit must be taxed, and there is an argument that the ‘official rate of interest’ may be too modest as a measure of the benefit of an unsecured loan. But equally unquestionably the only person who should be taxed in respect of the benefit is the person receiving it: there should be no place for an additional charge on the company.

Another justification sometimes trotted out is that since the making of a loan is (at least in cashflow terms) a bit like paying a dividend, it is reasonable that it should be provisionally treated as a dividend unless and until it proves not to be: hence, the historical linking of the rate of s 455 tax to the rate of advance corporation tax payable on a dividend. But if such an argument ever held water, it hasn’t since ACT was abolished 20-odd years ago. Paying a dividend has no tax consequences for a company: why should paying something that looks a bit like a dividend only if you squint?

Ultimately, one often feels when speaking to clients about s 455 that one is defending the indefensible. ‘It’s the law, get over it’ is hardly an ideal response, but it is sometimes hard to say much else!