The recent First-tier Tribunal (‘FTT’) decision in M Group Holdings Limited v HMRC is a salutary reminder that there are a number of detailed conditions that need to be met in order for the substantial shareholdings exemption (‘SSE’) to apply to the disposal of shares by a corporate shareholder.
The chargeable gains tax regime was changed in 2011 to allow a group to reorganise its trading operations and qualify for a tax exemption under the SSE rules. For example, the extended rules allow SSE to apply where a group sets up a new company, transfers a trading asset to that company and sells the shares. Although there would potentially be a degrouping charge on the sale of the shares this is treated as increasing the sale consideration, such that provided SSE applies the degrouping charge is also exempted from tax. This strategy has been used in a number of cases in North Sea transactions.
The key conditions for SSE to apply are that the seller (investor) must have held a substantial shareholding in the company being sold (investee) for at least 12 months and that the investee must have been a trading company throughout that period.
If a trading asset has been transferred to the investee:
- the investor is treated as holding the shares; and
- the investee is treated as being a trading company;
at any time during the final 12 month period when that trading asset was previously used by a member of the group for trade purposes.
The taxpayer in M Group Holdings Limited v HMRC sought to rely on these extended SSE rules. The taxpayer was a single company owned by an individual with no other subsidiaries. This was the problem – the taxpayer was not a member of a group at that point in time. The taxpayer became a member of a group on the establishment of the investee company as its subsidiary. The investee company was established only 11 months before its sale.
HMRC contended that the rules would apply to extend the period of ownership of the investor but only to the extent that the investor was a member of a group. As that extended the period of ownership for only 11 months, the SSE conditions were failed and HMRC asserted that SSE could not apply. This interpretation of the rules follows HMRC’s published guidance.
The FTT agreed with HMRC that the application of the natural or ordinary meaning (i.e. literal interpretation) of the rules to the facts resulted in SSE not being available. On review of the legislation itself, explanatory notes laid before Parliament when the law was enacted, and the relevant consultation documents, the FTT could not find anything that supported HMRC’s position as the documents did not consider the precise point. However, that also meant that it did not assist the taxpayer’s position either. As the FTT could not establish the intention of Parliament on this narrow point it could not use a purposive interpretation.
The FTT found that this resulted in “..the oddity or arbitrariness of SSE applying or not depending on whether there has been a separate, possibly dormant, subsidiary or other group company owned for the previous 12 months”.
The FTT went on to consider whether the interpretation produced an unjust or absurd result. The FTT stated that “denial of SSE in the circumstances of this appeal appears odd” but it did not believe that there was sufficient clarity on Parliament’s policy intentions on this precise point to be able to conclude that this was a wholly unreasonable result. Therefore the FTT considered that it was not permitted to allow a strained interpretation of the rules. Furthermore, as an aside, the FTT noted that the wide interpretation of the enacted law required by the taxpayer to succeed would allow an investee to qualify if an asset was transferred to it from a trading company that had recently joined the group. The FTT found that this would be contrary to the purpose of the legislation and therefore the wide interpretation could not be the correct interpretation of the law.
This problem in the legislation has been known for many years and it is perhaps therefore not a surprising decision. Indeed the approach taken by the FTT is actually set out clearly in the HMRC manuals.
There seems to be no policy reason why SSE should not apply here and therefore this appears to represent a flaw in the drafting of the legislation. However, the Courts have strict rules when interpreting legislation and as there was no clear purposive intent identified in the legislation or supporting papers the FTT did not feel able to follow anything other than a literal interpretation of the statutory provision.
Given the amounts involved, it is likely that the issue will be appealed by the taxpayer.
We have advised “single group” companies to ensure that they establish a dormant subsidiary if there is a possibility that they may wish to rely on the extended SSE rules for a future disposal.
In addition, although the facts, in this case, are perhaps unusual, particularly in the oil and gas world, there are other circumstances where the “assets used by a group condition” might need to be carefully looked at if SSE is to apply. For example where the purchaser of a company looks to on-sell assets in the acquired group within 12 months.
On a broader view, the case reinforces the point that detailed analysis of legislation is always required when seeking to understand the tax implications of any transaction. The UK tax courts can find it difficult to interpret legislation in a way that perhaps taxpayers might expect or hope for, as opposed to what the legislation actually states.
CW Energy LLP