Key points

• A company incorporated a new subsidiary before effecting a sale.
• Extension to the substantial shareholdings exemption arising from FA 2011.
• Tribunal concluded the exemption did not apply to stand-alone trading companies.
• Did parliament intend it should apply only to a group member?
• The current interpretation has no discernible policy behind it.

Oscar Wilde might have said that there is only one thing in the world worse than being mentioned in a tax case, and that is not being mentioned in a tax case. I was quite excited to be alerted by a friend to the fact that I had been mentioned in a First-tier Tribunal case, specifically, M Group Holdings Ltd (TC8054). I was slightly disappointed to discover that the judge decided that my words of wisdom had no weight in helping him reach a decision, and that the company lost, which suggests that the tribunal considered my views to be incorrect.

What’s it all about?
The owner of M Group Ltd (MGL), Mr Jeffreys, was aware that potential buyers were interested in the company but that the company had some contingent liabilities, arising from previous tax planning, that made it an unattractive prospect. He was therefore advised to restructure the business, as follows:

• incorporate a new subsidiary, MCS;
• hive down the trade and assets of MGL’s business to MCS; and
• sell MCS.

The subsidiary, MCS, was sold for just under £55m and MGL claimed that the substantial shareholding exemption (SSE) applied (TCGA 1992, Sch 7AC), so that there was no corporation tax on the chargeable gain. A further consequence of that claim is that there would be no degrouping charge, as the degrouping element of the gain would also be exempt by virtue of s 179(3D).

HMRC disagreed and amended the company’s tax return to show corporation tax of about £10.6m due from MGL. This would arise from the combination of the degrouping charge and any actual gain on the shares being sold.

Substantial shareholding exemption
Very broadly, the substantial shareholding exemption applies in cases where a company sells shares in a trading company. The shares must have been held for at least 12 months before the disposal and the company being sold must have been a trading company for that same period. In this case, however, MCS had existed only for 11 months when it was sold and had been trading only for eight.

However, MGL was relying on an extension to the exemption. This arises from amendments made to the SSE in FA 2011 which deem the shares to have been held, and the company to have been trading, for the requisite 12-month period, so long as particular conditions are met (Sch 7AC, para 15A(2)(a) to (d)), as follows, with company names inserted for clarity:

a) immediately before the disposal, the investing company (MGL) holds a substantial shareholding in the company invested in;
b) an asset which, at the time of the disposal, is being used for the purposes of a trade carried on by the company invested in (MSC) was transferred to it by the investing company (MGL) or another company;
c) at the time of the transfer of the asset, the company invested in (MCS), the investing company (MGL) and, if different, the company which transferred the asset were all members of the same group; and
d) that the asset was previously used by a member of the group (MGL) – other than the company invested in (MCS) – for the purposes of a trade carried on by that member at a time when it was such a member.

If the conditions are satisfied, MGL would be treated as holding the MCS shares for the period that the asset was used as mentioned in (d) (Sch 7AC, para 15A(3)) and MCS would be treated as being a trading company for the same period (Sch 7AC, para 19(2B)).

It was accepted that the three conditions at (a) to (c) were satisfied. Immediately before selling MCS, MGL owned all of the shares of the company; at the time of the disposal, MCS was using assets for the purposes of the trade that had been transferred to it by MGL; MGL and MCS were members of the same group at the time when the assets were transferred. Incidentally, I assume that any goodwill or intangible assets of the trade were pre-FA 2002 assets and were dealt with under the capital gains regime and not under the corporate intangibles rules, which would have created a degrouping charge under CTA 2009, s 780.

It was also accepted that the fourth condition, (d), was satisfied – the assets transferred to MCS had been used by a member of the group, ie MGL, at a time when that company was a member of the group. The difficulty is that HMRC interprets this provision as applying only to the period when MGL was a member of a group, which started when MCS was formed. Thus the period referred to in TCGA 1992, Sch 7AC, para 15A(3) and 19(2B) was only the 11 months from the formation of MCS to the sale, which was not the full year required by the legislation for the exemption to be available. This view is explained in HMRC’s Capital Gains Manual at CG53080C.

The counterargument on behalf of the company was that the legislation does not require MGL to be a member of a group during the entire 12-month period referred to in paragraph (d). That is also my understanding of the original intention behind the FA 2011 changes, which I shall come to later.

Principles of construction
There was a lengthy discussion about the principles of construction and it appears that the parties agreed:

• Legislation must be interpreted purposively.
• If a plain construction produces injustice or absurdity, another interpretation may be preferred if it avoids that injustice or absurdity, even if it is a strained interpretation. However, that strained interpretation must be one that ‘the language [of the legislation] admits’.
• If strained interpretation does not help, under some circumstances the courts can go further to correct drafting mistakes. In such cases, the judiciary must be ‘abundantly sure’ of three elements: the intention of parliament, the failure to give effect to that intention was inadvertent and the wording that would have been used if the error had been spotted.

Evidence
Both parties also referred to non-statutory material in their arguments. HMRC referred, in particular, to the explanatory notes to the Finance Bill and to the consultation document that discussed the FA 2011 changes.

The company prayed in aid several articles in Taxation magazine and Tax Journal to illustrate that other commentators agreed with the company’s interpretation, while accepting that the tribunal was not required to construe tax legislation on the basis of such articles. Incidentally, it was here that an article of mine, ‘Ironing the wrinkles’ (Taxation, 23 June 2016, page 10), was mentioned and my comments on the specific point were quoted:

‘Paragraph 2.12 refers to a change made in FA 2011 to allow a trade to be packaged into a new company (the investee company) and disposed of with the SSE applying (see TCGA 1992, Sch 7AC para 15A). Previously, the exemption unnecessarily forced a company to have each separate trading activity in a separate trading subsidiary. Consequently, singleton companies that carried on several trades were at a disadvantage. The 2011 change was intended to permit a singleton company to hive down a trading activity into a new subsidiary and to sell that subsidiary subject to the SSE. For no good reason, however, HMRC interprets the legislation as meaning that the company must, in fact, have been a member of a group before the transfer, so that the new rule cannot apply to singleton companies (see HMRC’s Capital Gains Manual at CG53080C). This is not what was originally envisaged, and nor is it the way in which the draft legislation was interpreted by those of us who were involved in the consultation leading to the 2011 changes. When challenged, HMRC’s comment was that this is not a particularly onerous issue to address, which presumably means we are expected to incorporate a £100 dormant subsidiary for every multi-trade singleton company in our client portfolios.’

The arguments
Overall, HMRC’s approach was that the legislation was clear and should be interpreted according to the plain meanings of the words. The intention behind the legislation was demonstrated beyond doubt by references in both the explanatory notes to the Finance Bill and in the consultation document to the changes being applicable to groups of companies, rather than to stand-alone companies, such as MGL. Finally, parliament was entitled to enact legislation that created bright lines which, while it might give some odd results, were not necessarily unjust or absurd or unintentional according to some discerned policy. The 12-month grouping requirement in this legislation might be such a bright line.

For the company, however, it was argued that there is an injustice or absurdity in the legislation: had the sale been delayed for an extra month, or had MCS been created a month earlier, the problem would not have arisen. It followed that the tribunal was entitled to correct this injustice or absurdity by its interpretation of the legislation. It was also absurd that parliament would have intended to extend the SSE to cases where a trade was being hived out of a divisionalised company that was a member of a group, but not to a divisionalised company that stood alone.

The judgment
The tribunal first found that, on the plain wording of the legislation, the purpose was ‘to extend SSE to the sale of shares in group companies that hold assets previously used by the group for the requisite period’. The judge was unable to tell from the wording of the legislation whether the intention was also to provide relief for stand-alone trading companies, although it was noted that extending the exemption in the way proposed by the company ran the risk of allowing the SSE to apply to cases where a trading subsidiary was acquired and then sold within a year.

However, the judge also agreed that, ‘HMRC’s construction produces what might be described at the very least as 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’. He also agreed with the company that there was no obvious policy reason for that distinction. At this point, the judge in effect discounted all of the non-statutory materials that have been produced by counsel for both parties and went on to consider the point about arbitrariness or absurdity.

He accepted the possibility that HMRC’s argument about bright lines in legislation had some merit, although this would not always be the answer. But he also said that being odd or arbitrary is not enough to require a strained interpretation to be applied. It is also necessary to be able ‘to determine with confidence “the obvious intention of the legislation” on this specific issue, whether from the legislation or the extra-statutory materials’. In effect, if it is not possible to determine the intention of parliament, it is not possible to decide whether there is a wholly unreasonable results that would justify applying a strained interpretation, instead. As the judge succinctly said: ‘Put simply it is not obvious that parliament intended stand-alone companies with newly acquired subsidiaries to benefit from SSE. That is in my opinion sufficient to dispose of the argument.’

He went on to say that, even if he were wrong, it was not possible to construe the legislation in the way that the company contended. Indeed, to do so would be to open the door to wider use of the SSE that parliament almost certainly did not intend, such as the exemption applying to cases where a trading subsidiary was acquired and then sold within a year, as mentioned above.

Finally, for completeness, he considered whether this was a case where words could be read into the legislation to correct a drafting error. However, since he had already said that parliament’s intention was unclear, he could not be abundantly sure of parliament’s intention, following the tests mentioned above.

Discussion
This case is interesting: first, for its discussion of the principles of construction and, in particular, when legislation can effectively be reinterpreted by the tribunals or courts, either by straining the construction of the plain words of the legislation or by reading words in.

From a personal perspective, however, I find this case interesting because I was involved in the genesis of what became para 15A, so I know what the original intention was. At FA 2010, the then chancellor started a review of the impact of the capital gains rules on groups of companies. So the emphasis on groups by both HMRC and the tribunal judge is not obviously misguided. However, as part of that review, HMRC and the Treasury convened a discussion group with a number of tax professionals, including me. At one of those meetings, we explained that the SSE had the effect of discriminating against companies that chose to operate different businesses or parts of their businesses through different divisions within the same company, rather than having separate subsidiaries. For example, a holding company with three trading subsidiaries would be able to sell any one of the three trading subsidiaries – indeed, nowadays, it would be able to sell all three – without a tax charge, under the SSE. However, if another company had chosen to operate its three trading activities through different divisions, there was no equivalent of the SSE to exempt it from corporation tax on any gains. In effect, therefore, the tax legislation was forcing companies to form groups, suffering increased compliance costs, additional complexities around cross-charging, group relief and other tax issues, simply so that they might be able to take advantage of the SSE as and when a subsidiary were sold.

For those of us involved in that meeting, the archetypal case for such discrimination is the stand-alone divisionalised company. If anyone had suggested that the SSE should apply only to a divisionalised company that was already a member of a group, we would have suggested that was an absurd policy position to take. Therefore, when the amendments to the SSE were first published, we understood them to be applicable to singleton companies as well as to divisionalised group companies. Indeed, the references to groups in paragraphs (c) and (d) above were, in our view, an extension of the relief from stand-alone companies to divisionalised companies that were members of groups, which is the opposite of the outcome of this case.

Proposed changes
After the publication of the draft legislation, HMRC convened a workshop to discuss the proposed changes. There were lengthy discussions about the proposed changes, including these new rules for the SSE, but I do not recall any suggestion from HMRC that this extension of the exemption was intended only to apply to companies that were already members of groups and not to singleton companies. Indeed, the first inkling I, and many others, had of this view was when HMRC’s guidance was published and CG53080C stated HMRC’s position. It was at that point (November 2012) that I had some email correspondence with the relevant HMRC team and I was told that ‘the main issue was presented to us in the context of existing groups (albeit ones with a lot of activity in a single company)’. That is certainly not how I remember the conversation that led to the changes to the SSE.

Oddly, given the general state of tax planning and around this time, the email ended with the phrase ‘it does not strike me as a difficult or burdensome point to plan for’. I took this to mean, as mentioned in the extract from my Taxation article above, that we should be advising clients who owned singleton companies with multiple trading activities to consider incorporating a £100 subsidiary, so that they would be able to take advantage of para 15A without having to wait 12 months after a hive down to a new subsidiary.

What intrigued me in particular is that one might argue that such a subsidiary would have been put in place for no commercial reason other than to obtain a tax advantage, which would appear to go against the grain of the Ramsay doctrine. The current formulation of that doctrine – that legislation should be construed purposively and that transactions should be looked at realistically – comes out of Collector of Stamp Revenue v Arrowtown Assets Limited [2003] HKCFA 46, which, ironically, is a case where a genuine shareholding, with rights to appoint a director to the board of a company, was ignored as having no genuine commercial significance other than to avoid stamp duty in Hong Kong. So we have one branch of HMRC suggesting a form of tax planning that other parts of the department and the courts were striking down.

One slight difficulty with M Group is that it did not involve the sale of divisionalised business, and the reason that the purchasers did not want to buy the trade in the existing company was because of some legacy tax planning issues. So the planning was designed to try to obtain a favourable tax result for the shareholders of a company who had a track record in what HMRC presumably considered to be offensive tax planning or avoidance. This should be irrelevant to the decision on the technical issue but, as objective as we all try to be, it is virtually impossible to avoid being subconsciously affected by prior knowledge, which could inadvertently have flavoured the tribunal’s decision.

Intent of parliament
The other area that I find interesting in the context of this case is this concept of the intention of parliament. The legal fiction is that, because laws are created by parliament, there must be an intention of parliament in enacting legislation and this intention must be sought in all cases. But anyone who has attended parliamentary debates on tax issues will be well aware that most parliamentarians know virtually nothing about tax and have even less interest. We are told that the intention of parliament must be sought from the words of the legislation, which are written by parliamentary counsel. But parliamentary counsel is instructed by HMRC officials, so the words of the legislation are the product of HMRC’s instructions. In effect, the practical reality in most cases is that the so-called intention of parliament is really the intention of HMRC officials.

The guidance is invariably written sometime after the legislation has come into force and often by other HMRC officials, the original team having moved on to better things. This often creates its own difficulties in terms of a mismatch between what was understood to be the intention of HMRC at the time legislation was enacted and the intentions stated in the guidance. This may not have happened here but I reiterate my point, that the guidance at CG53080C was a surprise to many of those who had been involved in the discussion groups and the subsequent consultations over the FA 2011 changes.

Particularly distressing about this case, in my personal view, is that a sensible change to the tax code to allow companies to choose whether to be divisionalised or to form a group structure has somehow been subverted into something very different, with no discernible sensible policy behind it and, in M Group, about a £10.6m adverse consequence to the company concerned.

Wider picture
Looking at the wider picture, I will not be the only person who thinks that HMRC’s interpretation of para 15A is absurd and that there is no policy justification for extending the SSE to companies with multiple divisions that are already members of groups, but not to singleton companies.

I hope the taxpayer appeals and that either the Upper Tribunal or the higher courts ultimately find in favour of the taxpayer.