Purposive construction of legislation? Looking at the composite transaction? It’s supposed to work both ways. The Court of Appeal decision in Khan [2021] EWCA Civ 624 suggests it doesn’t.
A company was nearing the end of its life. A deal was done whereby the three shareholders would extract the bulk of the value from the company (nearly £2m) and sell the depleted company to Mr Khan for £20,000. Mr Khan would supervise the orderly closing down of the business followed by winding up or strike-off.
But the legal structure adopted wasn’t quite that simple. The paperwork showed Mr Khan as buying all the issued shares from the vendor shareholders for roughly £2m and the company as immediately repurchasing all but one of them from Mr Khan for about £20,000 less (the difference being, in effect, what he was paying for the rump of the company). Meanwhile (since Mr Khan didn’t have £2m spare) the cash for the purchase price had come out of the company, and after bouncing in and out of Mr Khan’s bank account in a nanosecond had been paid (via Mr Khan’s solicitors) to the vendors in accordance with the pre-agreed arrangements and undertakings. The net effect was that:
- Mr Khan ended up one share richer and £20,000 poorer (having never had meaningful or effective control over either the remaining shares or the £2m paid for them)
- The former shareholders had disposed of their shares and received roughly £2m
- The company’s assets were diminished by roughly £2m and its share capital reduced from 99 shares to 1 share
Most people would have said that, regardless of the legal form, this was in substance a repurchase of shares by the company. It may be said with some confidence that if it had resulted in a higher tax bill, HMRC would have argued that tax should be levied in accordance with the substance not the form of the transactions. And few would have taken serious issue with that.
However, in this case, the legal form (viz., that Mr Khan had bought the shares personally and immediately sold them back to the company for substantially the same figure) resulted in a £2m ‘distribution’ from the company and a tax liability of £600,000 arising out of thin air. And so – of course – HMRC resisted Mr Khan’s attempt to argue that tax should be assessed by reference to substance and insisted that what mattered was to look at each transaction step by step and assess the tax consequences of each in isolation. Look at the composite whole? Nah. Consider whether Parliament could really have intended a tax bill of this size to have arisen in these circumstances? Tough.
HMRC’s mantra of ‘paying the right amount of tax’ will sound very hollow to Mr Khan. He won’t be alone.
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