Key points

• Has a relocation to Birmingham triggered a changed attitude in HMRC’s clearance facility?
• The commercial purpose test and its relationship to corporate activities.
• The Clark case held that there is no requirement for a connection between a company’s activities and the commercial purpose for a share transaction.
• HMRC is applying a new test of necessity to the commercial purpose test.
• Is a general intention not a sufficient specific commercial reason for a transaction?
• Ensure that full details of relevant cases are included in correspondence to HMRC and the tribunal. Delays in the clearance and tribunal process have adverse commercial impact.

Many readers may be aware of major changes in HMRC’s clearance facility over the past couple of years. Initially, these appeared to be purely administrative – on the retirement of the long-time head of the clearance team HMRC had decided to transfer the unit to Birmingham and recruited Birmingham-based staff into the team and appointed a new team leader. It is not clear whether the remaining members of the London-based team were offered the opportunity to relocate, but it appears that none did. By about this time last year, all the names familiar to those working in clearances had, apparently, been redeployed.

Clearly, a mere change of personnel is not enough to warrant an article in Taxation, but it has become apparent over the past 18 months or so that the new team is taking some positions that are very different from their predecessors. This has caused uncertainty to advisers and taxpayers alike, as the certainties of the previous 30 years or more (of my own experience) were swept away and we have to learn to cope with new approaches.

This was difficult enough in itself, but the general upshot of HMRC’s changes of views was that some fairly standard transactions, which had invariably been granted clearance under the old regime, were now refused. I will highlight the issues that the new team has raised and explain why I think their approach is incorrect.

Commerciality and the companies’ activities
The first issue that arose related to the commercial purpose test and its relationship to the activities of the company or companies involved in the transactions. Readers will be aware that, for tax-free share exchanges and schemes of reconstruction, it is necessary for a transaction to be carried out for bona fide commercial purposes (TCGA 1992, s 137(1)). There is a second test that the transactions are not part of a scheme or arrangements, the main or one of the main purposes of which is the avoidance of capital gains tax or corporation tax. For schemes of reconstruction the corporation tax relief also requires there to be no intention to avoid income tax.

The first inkling that HMRC’s attitude towards these tests had changed is that it started asking how the commercial purpose explained in a clearance application related to the trade or business carried on by the companies involved.

For example, if the transaction was a share exchange, whereby a holding company would be inserted above an existing trading company, the question would be how that holding company would benefit the activities of the trading company. Some might think that this is a reasonable question to ask, but the important point is that there is nothing in the legislation to require a connection between a company’s activities and the commercial purpose for a transaction involving its shares. This was explicitly stated in Clark v CIR [1978] STC 614.

In that case, Robin Clark was a shareholder in the family investment company, as well as being a farmer. When the opportunity arose to buy some more farmland he was keen to do so, but could afford to pay for it only if money could be released from the family company. This was done in a series of transactions, which HMRC said fell foul of the transactions in securities rules as they then stood (now at ITA 2007, s 684 et seq). The rules were substantially rewritten in 2010 – when the commercial purpose test was removed – and 2016.

HMRC argued that there was no commercial reason for the transactions. The Special Commissioners said: ‘The commercial reason must be connected with the vendor’s interests in companies concerned in or affected by the transaction’ and that ‘Robin’s farming venture, although commercial in nature, was something quite separate from his interests in companies in the family group. We hold, therefore, that the principal reason for which Robin carried out the transaction was not a “commercial reason” within the intent of the escape clause’. The commissioners decided in favour of the Revenue.

When Mr Clark appealed to the High Court, the judge said that the Special Commissioners had misdirected themselves in law. Once they had agreed that there was a commercial purpose for the transactions, the legislation ‘merely requires that the transaction must be “carried out for bona fide commercial reasons”. That language is entirely at large. If the taxpayer can prove that the transaction was carried out for bona fide commercial reasons, he satisfies the requirement of the section’. On that basis, the Special Commissioners’ decision was overturned.

Resultant delays
The statutory disconnect between the commercial purpose and the activities of the companies involved is clearly established law of more than 40 years’ standing before the new clearance team was appointed. When challenged on the relevance of this question, HMRC’s responses, in essence, acknowledged that the Clark case remains good law but stated that it is entitled to establish the commercial bona fides of the transactions.

I am sure we would all accept that HMRC is entitled to ensure that the statutory requirements are satisfied, but it is not acceptable to adopt an approach that seems to set aside one of the most basic principles underlying one of those requirements according to case law. Nor was this a short-term problem; even today, we see letters from the clearance unit asking for the connection between the commercial purpose and the activities of the companies.

The frustrating aspect here is that, while the clearances may eventually be granted, each round of correspondence is taking at least another month out of the client’s timetable. In the ‘good old days’, in uncontroversial cases, we could say to a client that clearance would come back within 30 days of the application – the statutory time limit (see for example, TCGA 1992, s 138(3)). Sadly, the 30-day time limit appears to be more of an aspiration than a statutory deadline at the moment, but each round of irrelevant correspondence therefore adds at least another month before clearance is granted.

Commercial necessity test?
The second problem we are seeing is that the new team has decided to apply a new test of necessity to the commercial purpose test. Although the legislation simply requires that the transactions be carried out for a commercial reason, HMRC’s new approach appears to ask whether, given the commercial reasons explained in a clearance application, the exact transaction that is proposed is necessarily the answer to that question. Again, this is contrary to the clear words of the statute and case law.

To give a simple example, albeit one that is causing a great deal of difficulty at the moment, let us imagine a company which is trading profitably and generating cash. The shareholders do not need to pay dividends, but they would rather the cash was not subject to the risks inherent in their trading business. The natural next step in the evolution of the business is to insert a holding company and distribute the cash up to it so that it can be stored safely until it is needed, either for further business purposes or to fund dividends. This is a commercial transaction which, until recently, we would all have considered completely uncontroversial.

However, the clearance team’s current attitude appears to be that there are at least two ways in which the cash can be protected from trading risk. Either we could insert a new holding company and store the cash there, or the cash could simply be distributed to the shareholders. On that basis, since it is not necessary to insert a new holding company, the insertion of the new holding company apparently fails the commercial purpose test and clearances are routinely being refused for these and similar cases.

Quite apart from the absurdity of the suggestion that the cash is ‘protected’ from risk by distributing it to the shareholders and suffering a tax charge of at least 32.5%, HMRC’s approach is clearly incorrect in terms of both the legislation and case law because there is no test of necessity in the legislation. It also leads to a logical absurdity: in this case there are alternative mechanisms to achieve a particular commercial aim of protecting the company’s profits. One is paying a dividend to shareholders and the other is to use a new holding company. HMRC says that using a new holding company fails the commercial purpose test, because there is another way of doing it – paying a direct dividend. But by the same argument, we could also say that paying a dividend directly to shareholders would fail a commercial purpose test (if there were one), because there is another way of doing it. Thus, HMRC’s approach leads inexorably to the conclusion that the commercial purpose test can only ever be satisfied if the transactions being proposed are the only way to achieve the commercial aim.

Conversely, my view, and the argument accepted by the High Court in Snell (see below), is that the statutory test is whether the transaction is carried out for bona fide commercial purposes, so that, regardless of which mechanism is used to achieve that commercial aim, that mechanism satisfies the commercial purpose test.

Snell v HMRC
This view was affirmed in the case of Snell v CRC [2007] STC 1279. Mr Snell sold the shares in his family company for about £7m, settled in loan notes. This would normally be treated as not involving a disposal of the shares or as an acquisition of the loan notes under the share exchange rules (TCGA 1992, s 135). Instead, the gain would arise as and when the loan notes were redeemed. However, Mr Snell went to live abroad so that, by the time the loan notes were redeemed, he was not UK resident and not subject to capital gains tax. HMRC took the view that this contravened the anti-avoidance provisions discussed above. It argued that the transaction was not carried out for genuine commercial reasons and that it was part of a scheme of arrangement to avoid capital gains tax. Although Mr Snell lost on the second point, because the Special Commissioners and High Court agreed that the arrangements were intended to avoid capital gains tax, it is crucial to our argument here that Mr Snell won on the first point.

HMRC’s position was that the transaction to be considered was the share exchange transaction whereby he sold his shares in return for an issue of loan notes from the purchaser. Both the Special Commissioners and the High Court disagreed and said that the commercial reason to be considered was simply the fact that he wanted to sell his company. In effect, the decision said that, once we accept that there is commercial purpose, there is no requirement, in the context of that test, to look at the mechanism that is used. This is particularly clear from the fact that parliament had inserted a specific test of tax avoidance to cover those cases where the genuine commercial reason was nevertheless achieved in a way which avoided capital gains tax or corporation tax.

High Court judgment
The key passage is paragraph 12 of Sir Andrew Morritt’s judgment in the High Court (emphasis added):

‘Sections 135 and 136 apply those provisions to exchanges of securities, whether involving a scheme of reconstruction or amalgamation or not, in which more than two persons are involved. In such circumstances it is obviously necessary for the exchanges to be for commercial reasons if the new and the old holdings are to be treated as the same. But if there is appropriate identity and value commensurate with bona fide commercial reasons I can see no reason why parliament should have been concerned with whether the same result might have been achieved by some other legal form or means. This is particularly so when the same subsection introduces a non-avoidance test by reference to the scheme or arrangements as a whole. In my judgment this conclusion is confirmed by the wording of the subsection. The question is whether “the exchange in question … is effected for bona fide commercial reasons”. If the answer is in the affirmative it is irrelevant to consider the reasons why the parties chose to structure their transaction in that way. For these reasons I dismiss the cross-appeal of the Revenue.’

To relate that to the scenarios we have been seeing regularly, HMRC has routinely refused clearance for the insertion of new holding companies on the basis that there is no commercial reason for doing so, since the accumulated profits of a business can be protected just as well by distribution directly to shareholders. By analogy with the decision in Snell, I would say that the bona fide commercial reason for carrying out a transaction is to protect the company’s accumulated profits. That satisfies the first leg of the test, and there is no requirement to consider the specific mechanism chosen to protect those profits because the statute does not require this. Further, as in Snell (since we are looking at the same statutory test), parliament has inserted a separate test covering the avoidance of capital gains tax and corporation tax. So HMRC’s stance is, very simply, the same one that was robustly struck down by both the Special Commissioners and the High Court in Snell.

As we will see later, I am pleased to be able to report that tribunal judges are aware of this and have reversed HMRC’s decisions in a number of recent cases that I am aware of.

Specificity of commercial purpose
Another reason that is often given for inserting a new holding company is to allow the accumulated and undistributed profits to be applied to other business ventures. It is not uncommon for companies to form a group in this way to start a new trading activity or to apply the surplus profits to the acquisition of investment properties. In both cases, it makes sound commercial sense for these activities to be in separate companies from the trading company. In many such cases, HMRC is denying clearance on the basis that there is insufficient clarity as to how the proceeds are to be invested. It has clearly stated in correspondence that it considers a general intention to invest in further business activities is not a sufficient specific commercial reason for the insertion of a new holding company by share exchange.

This argument seems to assume that a commercial reason can only exist if it has been formulated in full detail, rather than being a general concept that will be fleshed out later, although such a view is not supported by the legislation. Further, particularly in the context of acquiring investment properties, it is not very commercial to suggest that clients should, in effect, be on the point of acquiring a property before they are entitled to set up the appropriate structure to make that acquisition. Property markets can be fast moving and an offer that is acceptable to a vendor might cease to be quite so attractive if they are asked to put everything on hold for two or three months while HMRC clearance is sought to allow the group to reorganise.

Once again, I am aware of a number of decisions by tribunal judges which have made it quite clear that a relatively amorphous desire to apply the company’s profits to the acquisition of investments or to the starting of a new trade is a sufficient commercial reason for clearance to be granted, even if the taxpayers have not yet decided on the detail.

Transmission to the First-tier Tribunal
I mentioned decisions by tribunal judges in these cases. This article has so far concentrated on clearance applications under TCGA 1992, s 138. Subsection (4) states that if HMRC has refused clearance for a transaction taxpayers are entitled to require the department to send the correspondence to the First-tier Tribunal, where the decision will, in effect, be remade by a tribunal judge. This does not need any referral on a point of law, nor is there any scope for either party to appear or to make written representations beyond the correspondence with the clearance unit. So it is a relatively simple and theoretically painless mechanism and one that I heartily recommend in appropriate cases. These are not published decisions like decided cases; in each one, it is simply a tribunal judge deciding whether to grant clearance and communicating that decision to the taxpayer and to HMRC.

As I have highlighted a few times in this article, tribunal judges have been helpful in granting clearances that the HMRC unit has previously refused. Further, the judges are producing detailed and reasoned decisions, highlighting why they disagree with HMRC’s position. Under the old regime, I am aware that decisions from the First-tier Tribunal were taken seriously and might on occasion lead to a change of view by the clearance unit. I like to think that this is because it would consider why decisions were being made and would consider whether, in fact, the tribunals had a better view. I hope that the current clearance team will consider the recent tribunal decisions similarly.

There are, however, a couple of caveats to a referral to the tribunal on the length of the process and relevant tax cases.

Length of the process
My experience is that the process takes several months. In a recent case, the papers were transmitted to the tribunal in early June 2020. The reasoned decision from the judge was issued to the taxpayer and HMRC in early January 2021, meaning that it took about seven months to deal with the case. By that stage, the client had come to the view that their preferred commercial approach to the problem was not tenable and they certainly were not in a position to wait so long for a decision, having already had correspondence with the clearance unit over three or four months beforehand. So while the decision was helpful in the wider context, it was, as my client put it, about as useful as a chocolate teapot to them. This is not to criticise the tribunals, by the way, because I think we are all aware of the present backlog of cases.

Relevant tax cases
My second caveat is to make sure that a full discussion of the relevant tax cases is included in the correspondence that is sent to the tribunal. This is because we cannot assume that tribunal judges are steeped in the arcana of the legislation and decided cases around clearances and the relevant statutory tests. It is our job to spell out these matters in as much detail as possible in the correspondence with the clearance unit so that the arguments are made in the papers which are then transmitted to the tribunal. This is not to say that we need to double the length of our clearance applications at this stage.

My general approach is to write the normal form of clearance application, on the assumption that the clearance unit will apply the right tests and grant the clearance that I have requested. Obviously, I will tailor this approach in cases if I am aware that HMRC’s views, such as described above, might require some further detail.

However, if it becomes clear through correspondence that HMRC is not going to grant the clearance, I will send one final letter asking it to reconsider. This letter will, first, rehearse all the arguments and counter-arguments that have been made throughout the correspondence, to ensure that everything is set out clearly in one place. Second, I will also make sure the letter contains a detailed discussion of any relevant tax cases, so that if the correspondence is eventually transmitted to the tribunal, all of that information is also laid out for the tribunal judge.
Invariably, HMRC will simply write back, eventually, refusing clearance again. But we can then ask it to transmit the papers to the tribunal knowing that the judge will be presented with a reasoned set of arguments that are based fully on both the statutory wording and decided cases.

This approach avoids issues such as I encountered in an early case, where the decision from the tribunal mirrored the original Special Commissioners’ decision in Clark. It was not quite on all fours but the decision to refuse clearance could be read as agreeing that there was a commercial purpose for the transactions, however the purpose was too remote from the activities of the relevant company. Had I been involved at an earlier stage, I would have made sure that there was a full discussion of Clark in the correspondence, so that the tribunal judge would have been aware of that case and its ratio decidendi.

Lessons to learn
The first lesson is that the appointment of an entirely new team with different views and approaches to granting clearance means that the continuity of approach that we have been used to for at least the past 30 or so years can no longer be relied upon. While HMRC’s views have evolved considerably in that period, changes were gradual, which is probably why it has come as a great shock to many of us in this field to be faced with a sudden and almost total change.

It is, of course, important that HMRC operates the statutory tests properly and we cannot fault the department for giving due consideration to the requirements that the transactions be carried out for commercial reasons. What is not acceptable, in my view, is that there appears to be a degree of apparent indifference to the legislation and decided cases contrary to that which taxpayers are entitled to expect. While it may have been acceptable for an entirely new team to be unaware of the ramifications of the Clark or Snell cases, for example, it is not acceptable for these decisions to be ignored in correspondence 18 months or more later.

The lesson for those who apply for clearances is to try to pre-empt HMRC’s questions by highlighting those cases, if it is relevant to do so. For example, if the commercial reasons for transactions clearly do have no effect on the business of the companies involved, we should remind the department in the original application that this is irrelevant, on the basis of the Clark case.

The overall practical result of the current situation is two-fold. First, we have to tell our clients that obtaining clearance might take somewhat longer than we were used to. In the old days, it was quite uncommon for a straightforward case to take more than a couple of weeks, sometimes less, for clearance to be granted, as the internal arbitrage system made sure that only difficult cases were retained for more detailed consideration. Nowadays, even the more straightforward and uncontroversial cases have become the subject for detailed and lengthy correspondence.

Second, despite a statutory time limit of 30 days for responding substantively to clearance applications, responses are routinely taking materially longer than this, as noted above. Our only sanction is to email HMRC on the 31st day and demand that it transmits the clearance application straight to the tribunal for a decision. But this is not a practical sanction, given, as noted above, that the tribunal can take up to six months to answer. So we are forced simply to accept a response when it finally arrives. This is another behavioural change I consider unacceptable, considering that in 30 years’ experience working with clearances, on both sides of the fence, I cannot think of a single occasion where a clearance application was not properly dealt with within the 30-day period.

The practical consequence of this, of course, is having to explain to our clients how long it might take to obtain clearance, even for a relatively uncontroversial transaction, and having to deal with the client’s disappointment at how long it might take to carry out what they would generally see as a straightforward transaction.

Where to next?
The issues in this article, and others, are being raised with HMRC by various representative bodies. We have been trying to engage with them since February 2020 but, to date, we have not been offered an online meeting and have had to put the issues to the Revenue in a somewhat piecemeal way by email. Nevertheless, we continue to push for proper engagement.

In the meantime, I mentioned earlier in the article that a number of decisions by tribunal judges have been in favour of taxpayers. Some of those decisions have been clear in stating that the judge considers HMRC’s approach to be incorrect. I would like to hope the department will start to see a theme developing and consider whether the tribunal decisions should better inform its original decisions in relevant cases.