An individual is chargeable to income tax on any ‘distribution’ from a company. ‘Distribution’ includes dividends but is widely defined (even more so in the case of a close company) to include pretty much any way in which value passes from a company to a ‘participator’ (broadly, a shareholder but – again – much more widely defined).
However, ‘distribution’ expressly doesn’t include returning money by way of repayment of share capital or of loans.
Overlaid upon the wide definition of ‘distribution’ are the ‘Transactions in Securities’ (‘TiS’) rules. Broadly, these provide that if, as result of a transaction in securities and with the purpose of avoiding income tax, a person receives something which could have been paid out as a distribution but was received in some way which does not give rise to a charge to income tax, the amount received is treated for tax purposes as if it were a distribution. The rules sit in the shadows, like a baleful spectre at the feast, whenever any transaction in securities is contemplated.
Thus, when contemplating any proposed transaction in securities, a key concern is whether it may be perceived by HMRC to involve a tax avoidance purpose, since without such a purpose the TiS rules cannot apply. The recent First-tier Tribunal (‘FTT’) case of Osmond and another v HMRC [2024] UKFTT 378 (TC) has something to say on that subject.
The case involved a company repurchasing some shares from some of its shareholders and repaying to them the capital which had originally been subscribed for them. Pausing there, you might be forgiven for thinking that as the definition of ‘distribution’ specifically (and perfectly logically) excludes from the charge to income tax a repayment of capital originally subscribed, it’s difficult to see how the TiS anti-avoidance rules could sensibly be applied to such a repayment. But that ship has sailed: in principle, they can.
The main point of interest in Osmond was whether the purpose (or one of the main purposes) of the buyback in that case was to avoid income tax.
The shares which were bought back benefitted from a valuable Capital Gains Tax (‘CGT’) relief, which the taxpayers apprehended might be withdrawn on a change of government. So they wanted to crystallise the CGT relief while it was still available. If they could have achieved that without effecting a share buyback, that’s what they would have done. They neither needed nor wanted to extract money from the company – that was an inevitable consequence of the buyback but not its purpose. All of that was accepted as fact by the FTT.
It’s worth reproducing the FTT’s summary of HMRC’s primary argument:
- Given the appellants’ stated purpose of securing [CGT] relief, it necessarily follows as a matter of law that they had a main purpose of obtaining an income tax advantage.
- [CGT] relief generates an income tax advantage. This is because obtaining [CGT] relief means the person is within the definition of income tax advantage as the CGT payable on the relevant consideration is less than the income tax payable if that relevant consideration had been paid to that person by way of a qualifying distribution.
- And so, if that person’s intended purpose was to obtain [CGT] relief, it must follow, as a matter of law, that the purpose was to obtain an income tax advantage as defined.
- The crucial point about this submission is that once the appellants’ submitted primary purpose of obtaining [CGT] relief is accepted, there is no need for any further analysis of the evidence. The purpose of obtaining an income tax advantage is established as a matter of law. (emphasis added)
The FTT described HMRC’s submission as ‘one which we have not seen made by HMRC in any previous case [and] which, at first blush, caused the judge to raise a quizzical eyebrow’. Nonetheless, the FTT accepted it: a purpose of crystallising the CGT relief was inevitably as a matter of law a purpose of obtaining an income tax advantage. And, as the FTT said, ‘we need go no further than that’.
In fact, the FTT did go further than that. It considered and rejected HMRC’s alternative argument that, ‘on the facts, the evidence shows that the appellants did have a main purpose of obtaining an income tax advantage’. The FTT held that ‘It was a CGT play. It was designed to ensure that they obtained the benefit of CGT relief now. They did not have, as a main purpose, the obtaining of an income tax advantage.’
It’s therefore a very curious decision: on the evidence, the taxpayers didn’t have a purpose of avoiding income tax: but as a matter of law they did.
Worrying decision, surprising consequences
Although we think that this decision will be appealed to the Upper Tribunal, it is meanwhile a very worrying one. Though it lacks the force of legal precedent it will almost unavoidably infect the approach which HMRC and the FTT take to the TiS rules. We think that the FTT’s initial reaction was right, and that the judicial eyebrow should have remained elevated.
The decision that a purchase of own shares which would otherwise be subject to CGT is (not ‘may be’ but inevitably ‘is’) caught by the TiS rules if it is accelerated in order to utilise a particular CGT relief has some surprising consequences.
Suppose the founding shareholder of a family trading company is contemplating that in the next year or two he will retire from the business, leaving the next generation to run it and selling his shares back to the company. It’s a common enough transaction and usually there would be no question but that it would be treated as falling within the CGT code and that CGT Business Asset Disposal Relief (‘BADR’) would be in point.
But suppose the shareholder, apprehending that BADR may be vulnerable on a change of government, decides to retire sooner rather than later, purely in order to ensure he gets the relief while it’s still around.
We cannot imagine that anyone would seriously describe that as a purpose of avoiding income tax. Yet it exactly parallels the position in Osmond; and following the principle of Osmond, it leads inexorably to the conclusion that the shareholder’s purpose (to secure a particular CGT relief before it disappears) automatically means that he has the purpose of avoiding income tax and is caught by the TiS rules. That simply cannot be right. And so, by a reductio ad absurdum argument, neither can HMRC’s argument or the FTT’s decision in Osmond. Thank goodness for the Upper Tribunal.
For more information on share buybacks and the TiS rules, please get in touch with your usual BKL contact or use our enquiry form.