David Whiscombe delves into a recent case on CGT holdover relief.
Imagine that you are a UK-resident self-employed trader. You want to incorporate your business. You do this by gifting the business assets to a UK company in which you hold 100% of the shares. You know that in such a case there is a special “holdover” relief that defers recognition of any capital gain that would otherwise arise.
We wager that you would be more than a bit surprised to be told that you aren’t entitled to claim the relief because your half-brother (whom you have never actually met) emigrated to Australia in 1991.
Yet that was the interpretation that HMRC sought to put upon the law in the recent case of Reeves [2018] UKUT 293 (TC).
The problem is that the law provides that the “holdover” relief in question is not available if the company to which you are transferring the business is “controlled” by a non-resident person who is “connected” with you. Add to that the fact that (a) the definition of “connected” is wide enough to include half-siblings and (b) any company that you control is treated as controlled by any “associate” of yours (which term also includes half-siblings); and you can see how the law appears to lead to this bizarre outcome.
But why on earth were HMRC seeking to defend such a manifestly absurd result? Indeed, given the enthusiasm with which HMRC argue for a purposive construction in tax avoidance cases, how did they have the chutzpah to contend in this case for a construction that cannot possibly have accorded with Parliament’s intention? For that we must look a little more deeply at the facts of the case.
Mr Reeves was not in fact resident in the UK. Nor were his wife and family. But he was a member of an LLP that carried on business in the UK. He would thus (despite his non-resident status) have been liable to UK Capital Gains Tax (“CGT”) on any gain made on disposing of his interest in the LLP. So, he did what many people in his position have done: he incorporated the business by transferring it to a company that he controlled. Any subsequent disposal of the shares would then be free of CGT.
In truth, HMRC’s real objection was that they thought that holdover relief ought not to be available because Mr Reeves was himself non-resident. Indeed, their primary contention before the Tribunal was that the law should be interpreted in that way. But, if their primary contention were to be rejected (as it was), they sought in the alternative to assert that the non-resident status of Mrs Reeves meant that the company was controlled by a non-resident connected with Mr Reeves, and thus to deny relief “by the back door”. The obvious weakness in that argument was that if the law was to be interpreted in that way, not only would it deny relief to Mr Reeves: it would also deny relief in the situation outlined at the start of this note. It’s troubling that HMRC didn’t appear to see that as a problem: it is as though they were so focussed on winning the case that the obvious “collateral damage” in the unconscionable consequential denial of relief in other cases didn’t count for anything.
In the event, the Tribunal held that the legislation could not have been intended to mean what it appeared to mean: it was absurd to suppose that Parliament had intended relief to be denied where the connected party had no personal interest in the company at all.
How the law should be interpreted was less clear. The Tribunal settled for deciding that, in the context of holdover relief, attribution could be made to an associate only if the associate held some personal interest (however small) in the company. Neither Mrs Reeves nor any other non-resident associate of Mr Reeves held any such interest, so the company was not to be treated as controlled by a non-resident and the relief was available.
The decision cannot be regarded as entirely satisfactory: it is almost as absurd to suppose that I am to be denied relief if my non-resident “associate” has a 1% holding in the company as it is if the associate has no interest at all. But, as the Tribunal put it, the line has to be drawn somewhere. Perhaps on appeal a higher court will find a better solution. Meanwhile, we have the uneasy position that the legislation isn’t quite as absurd as it appears to be. Just almost.
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