Key points

• Did Mr Osmond and Mr Allen’s share buybacks fall under the transactions in securities rules?
• The application of the transactions in securities regime ‘is intended to be very wide’ and potentially applicable whenever ‘consideration is paid in capital form’.
• Were the counteraction notices valid?

In my first two articles about Osmond and Allen (TC9163), I explored the decisions of the First-tier Tribunal (FTT) on the motive test and on whether the counteraction assessments were issued within the statutory time limit. This final article covers the other two elements of the judgment: whether a return of capital is effectively outside the scope of the transactions in securities rules (the relevant consideration argument) and whether the counteraction notices were validly issued. Spoiler alert: the FTT found for HMRC on both issues.

Background

To recap, Mr Osmond and Mr Allen held shares that were subject to EIS relief, so that if the shares were disposed of for capital gains tax purposes, no capital gains tax would arise on the disposal. During 2013, and again in March 2015, both of the appellants entered into share buybacks. The buybacks of March 2015 (£11m to Mr Osmond and £9m to Mr Allen) were challenged by HMRC under the transactions in securities rules.

Relevant consideration

One of the technical conditions for the transactions in securities rules to apply is that the taxpayer receives consideration (referred to as ‘relevant consideration’) ‘which is or represents the value of assets which are available for distribution by way of dividend by the company’ (ITA 2007, s 685(4)(a)(i)). It was generally agreed that the reference to assets available for distribution by way of dividend has been established to mean lawfully available to distribute (from Addy v CIR 51 TC 71) and would, in this scenario, be limited to the £36m of distributable reserves that were available in the company at the time of the 2015 buy-backs. In effect, this provision caps the amount of relevant consideration to the distributable reserves of the company (and, since 6 April 2016, by its subsidiaries – s 685(7B)).

However, the word ‘assets’ in this context is restricted to exclude ‘assets which are shown to represent a return of sums paid by subscribers on the issue of securities, despite the fact that under the law of the country in which the company is incorporated assets of that description are available for distribution by way of dividend’ (s 685(6), see The share capital restriction).

The share capital restriction ITA 2007, s 685(6) used to say: 'The references ... to assets do not include assets which are shown to represent a return of sums paid by subscribers on the issue of securities, despite the fact that under the law of the country in which the company is incorporated assets of that description are available for distribution by way of dividend.' This provision was repealed by FA 2016 and reenacted in slightly different words that are now in ITA 2007, s 685(7 A): 'The references ... to assets do not include assets shown to represent return of sums paid by subscribers on the issue of securities merely because the law of the country in which the company is incorporated allows assets of that description to be available for distribution by way of dividend.' It is not clear whether the current 'merely because' test is the same as the 'despite the fact' test in play at the time of the transactions in this case, so it's not certain how relevant this element of the decision will be for new cases.

HMRC’s arguments

HMRC’s argument, in a nutshell, was that the restriction in respect of amounts subscribed was simply to ensure that the maximum amount that could comprise relevant consideration for the purposes of the transactions in securities rules would be restricted to the actual distributable reserves, which were £36m in this case. It would not be increased by the share capital, even if that share capital were distributable as a matter of law. In effect, this provision acted as a cap, defining the maximum amount of relevant consideration. Since the share capital of a UK company limited by share capital cannot be distributed by way of dividend, s 685(6) has no application in the current case.

Appellants’ arguments

The appellants’ position was that the words, ‘do not include assets shown to represent return of sums paid by subscribers on the issue of securities’, meant that a return of share capital subscribed could not be caught by the transactions in securities rules, because a return of capital could not be a relevant consideration. My reading of their argument is that the words ‘despite the fact’ in s 695(6) could effectively be replaced with ‘even if’, so that relevant consideration could not include ‘assets which are shown to represent a return of sums paid by subscribers on the issue of securities, even if under the law of the country in which the company is incorporated assets of that description are available for distribution by way of dividend.’

The appellants also suggested that the December 2015 consultation document on company distributions (tinyurl.com/46r96wty) made it clear that HMRC considered the receipt from reducing capital (in a scenario similar to the current case) would be treated as a capital receipt. The example, Sebastian, is reproduced below. While it does, indeed, refer to Sebastian as receiving a sum of money that is a repayment of capital and subject to CGT, there is a footnote to the example that explicitly states that ‘this is an example of possible taxpayer behaviour. It does not reflect HMRC’s view of the correct tax treatment in all circumstances’. So I respectfully disagree with the appellants’ arguments here, and the tribunal did not read anything into the example, either.

Sebastian (Example 2 of the December 2015 consultation document) Sebastian is the sole shareholder of Sebastian Industries Ltd (SI Ltd), which was formed with £100 of share capital. After successfully trading for a number of years SI Ltd also has retained profits of £250,000 and no other assets. For a number of reasons Sebastian is advised to create a new holding company SI Holdings ltd (SI H Ltd) which is achieved via a share for share exchange in1w hich SIH Ltd issues £250,100 of share capital. Sebastian now holds all of the share capital in SIH Ltd, which hods alli of the shares in SI Ltd. SIH can repay £250,000 of share capital! to Sebastian. This transaction is classed as a repayment of capital and is subject to CGT.

The appellants also said that HMRC’s analysis meant that the restriction was redundant. I don’t agree, as I believe that HMRC’s point was simply that the restriction is only necessary in cases where a company’s share capital is distributable by way of dividend, so it’s correct to say that it had no application in this case, but it could be relevant in other cases.

Overall, the proposition being put forward by the appellants was that a return of capital subscribed could not be caught by the transactions in securities rules. This is a position that HMRC has successfully rebutted before, and they pointed out that such an interpretation would mean that the transactions in securities legislation could never apply to a share buy-back, which ‘would emasculate the legislation’, particularly the FA 2016 changes, which specifically added a repayment of share capital to the list of matters that are deemed to be a transaction in securities (ITA 2007, s 684(2)(e)).

In summary, therefore, HMRC was arguing that the £20m paid to the appellants was well within the £36m of distributable reserves, so the whole £20m was relevant consideration, and s 685(6) was not relevant. In contrast, the appellants’ position was that none of the £20m was relevant consideration, because it was a return of capital, which was the effect of s 685(6).

Intriguingly, both parties relied in part on the case of Marcus Bamberg (TC618), which included some useful discussions on this provision, which had previously been assumed only to apply to foreign companies (see, for example, Goff J in CIR v Addy, cited above).

Decision on relevant consideration

The tribunal also relied on Bamberg in coming to their decision in favour of HMRC. Its decision, in favour of HMRC, was that the restriction in s 685(6) was simply there to ensure that the transactions in securities rules do not inflate the amounts available for distribution by way of dividend by the adding share capital of the company in cases where that share capital is distributable as a dividend. So, in this case, which involved a UK company limited by share capital, the restriction was not relevant. In rejecting the appellants’ argument, the tribunal said that s 685(6) ‘does not operate as a free-standing exclusion clause. It must be read in the context of the legislation and the purpose for which it was enacted’.

Thus, we also have a purposive approach, whereby the tribunal preferred HMRC’s position as being better aligned with ‘the purpose for which the TIS regime as a whole was introduced’. The appellants’ interpretation would ‘be more than illogical, it would result in an absurdity. It would drive a coach and horses through the application of the TIS regime’. Overall, the application of the regime ‘is intended to be very wide’ and potentially applicable whenever ‘consideration is paid in capital form in circumstances where it would not otherwise be subject to income tax’.

Validity of the counteraction notices

One of the later steps in a transactions in securities enquiry is that HMRC must issue a ‘counteraction notice’ (assuming there is an income tax advantage to counteract), which must state ‘the adjustments required to be made to counteract the income tax advantage and the basis on which they are to be made’ and which must be served by an officer of Revenue and Customs (ITA 2007, s 698(2)). The ‘adjustment’ must be one of the four types listed in ITA 2007, s 698(4), but the only one relevant these days is an assessment.

The basis on which an adjustment is to be made is not defined and it has not been discussed in previous tax cases. If the adjustment is an assessment, it seems clear that it must mean the basis on which an assessment will be made, and this must mean an assessment to an amount of income tax equal to the relevant consideration, on the basis that no capital gains tax was paid on the transactions (ITA 2007, s 687(1)(b)).

The basis does not strictly appear to require the actual numbers to be specified in the counteraction notice. This is probably just as well, given HMRC’s somewhat bizarre proposition that they believed the counteraction notices to be compliant with the legislative requirements, despite ‘the only error being the amount of the assessment and the year of assessment’. The fact that both the amount of the assessment and the year of assessment were incorrect may not strictly matter, but it does not reflect well on HMRC.

HMRC’s arguments

HMRC’s contention was that the counteraction notices contained the required information (presumably, apart from the error of in the amount and year of the assessment). However, if the tribunal decided that the counteraction notices did not contain the prescribed information, there are three further reasons why the counteraction notices were nevertheless valid:

• notices must be read in context, not ‘in blinkers’, from Bristol & West v HMRC [2016] EWCA Civ 397;
• the counteraction notices refer to other documents that did contain all the required information, from R (on the application of Archer) v HMRC [2018] EWCA Civ 1962; and
• any invalidity is cured by the application of TMA 1970, s 114.

Bristol & West involved HMRC incorrectly issuing a closure notice in relation to an enquiry. Before this was posted or received by the taxpayer, the officer concerned had emailed the taxpayer and explained that the closure notice that had been issued was unintentional and should be disregarded. The Court of Appeal held that the correct interpretation must take into account how the notice ‘would be understood by a reasonable person in the position of its intended recipient’ and having that recipient’s ‘knowledge of any relevant context’. In the Bristol & West case, the closure notice was held not to have been validly issued, because it was clear that there had not been any intention to issue a closure notice, and it was equally clear from the overall context that HMRC had not suddenly conceded the case.

In the current case, the counteraction notices must therefore be read in the context of both the mini bundle of information that was issued at the same time, and in the broader context of the enquiry. The ‘reasonable person in the position of the intended recipient’, (the ‘objective reader’) would not have been in any doubt that the adjustment would be by way of assessment and the basis would be the amount necessary to counteract the income tax advantage.

In Archer, which also involved closure notices, the Court of Appeal accepted conceptually that a reference to a document in a closure notice could incorporate that document into the notice. Thus, in the instant case, where the counteraction notices referred to other documents, it was, again, ‘clear from these documents that the adjustment was to be made by way of an assessment and the basis on which the assessment had been made’.

Finally, HMRC was relying on TMA 1970, s 114, which states:

‘An assessment or determination, warrant or other proceeding which purports to be made in pursuance of any provision of the Taxes Acts shall not be quashed, or deemed to be void or voidable, for want of form, or be affected by reason of a mistake, defect or omission therein, if the same is in substance and effect in conformity with or according to the intent and meaning of the Taxes Acts, and if the person or property charged or intended to be charged or affected thereby is designated therein according to common intent and understanding.’

This is something of a ‘get out of jail free card’ for HMRC, but its scope is further extended by the decision in Archer, which said that the correct approach to this provision is to ‘concentrate on the nature and effect of the defect in the particular circumstances of the case’, such that it is the impact on the recipient that is to be considered, not some absolute measure of whether a notice is fundamentally or grossly flawed. HMRC did not think that any errors in the counteraction notices in the current case were fundamental, anyway (even if the quantum and date of the assessment were wrong). Its view was that an objective recipient of the counteraction notices would clearly have understood both the mechanism for the adjustment and the basis on which that adjustment would be made, thus validating the use of TMA 1970, s 114.

Appellants’ arguments

The appellants’ case was partly based on the fact that Officer Rounding had completed the counteraction notices, but the covering letter, HMRC’s view of the matter letter and the notice of assessment were completed by Officer Agnew. Since only Officer Rounding had authority to issue the counteraction notices, and some of the essential information was provided by Officer Agnew, it was not clear that Officer Rounding had authorised the information provided by Officer Agnew and therefore whether the counteraction notices had been validly issued. This would lead to sufficient ‘confusion in the mind of the objective reader concerning the actions and authority of the two officers’, that the counteraction notices could not be said to have been validly issued.

The Court of Appeal decision in Bayliss v Gregory [1987] 3 WLR 660, was that an error in the year of assessment in a notice of assessment was so fundamental that it could not be cured by TMA 1970, s 114. The decision in that case was that the ‘fiscal year of assessment was an integral and fundamental part of the assessment itself and notwithstanding the width of section 114 TMA, it cannot be used to treat an assessment for one fiscal year, as an assessment for another’. The appellants’ argument, based on this decision, is that some errors are so fundamental that they cannot be cured by s 114.

In summary, the appellants’ position here was that the counteraction notices were substantively incorrect and could not be cured by s 114, and that the omissions by Officer Rounding could not be cured by Officer Agnew, as he did not have authority to do so.

Decision on validity of counteraction notices

On the fundamental point, the tribunal agreed with Mr Gordon, that the counteraction notices were, on their face, incomplete. However, the judge agreed with HMRC that all the information was available in the documents accompanying the counteraction notices, which clearly showed the context of the ongoing enquiry and the potential for counteraction. So, while the counteraction notices might not have been valid on their face, the objective reader would have been fully aware of the relevant context, within the meaning of the Bristol & West decision, which cured the defects. Indeed, the tribunal pointed out that the information in the mini bundle associated with the counteraction notices was so comprehensive as to go ‘way beyond [the] statutory requirement’.

Although not part of the statutory test, the tribunal also pointed out that it was clear that the appellants and their advisers completely understood the meaning and impact of the counteraction notices.

The judges also gave short shrift to the suggestion that objective readers might have been confused by the different officers being involved. They considered that such confusion ‘would simply not have occurred to the objective reader let alone have been a point of concern or uncertainty’, and that the reader would not ‘have given a minute’s thought’ to different documents being authored by different officers.

This was sufficient to settle the point in favour of HMRC, but the tribunal considered the other two issues, the referencing of other documents and s 114, as both issues had been fully argued.

On the application of Archer, the tribunal held that HMRC had not made its case. They accepted that the counteraction notices referred to the statutory declarations and counter statements (which were then part of the administrative process for the transactions in securities regime), so that both of those documents must be considered to be incorporated into the counteraction notices. The problem for HMRC, however, was that neither of those documents explicitly stated either that there would be an adjustment by way of assessment or the basis of that adjustment. Therefore, the Archer approach of being able to incorporate documents referred to in a notice did not help HMRC.

In considering TMA 1970, s 114, the tribunal said that ‘one does not approach the application of section 114 TMA from the direction that some mistakes might be too fundamental or gross to fall within it. Instead, one needs to concentrate on the nature and effect of the omission in the particular circumstances of the case’. This was the way s 114 was viewed by the Court of Appeal in Archer, when the particular circumstances of Mr Archer were taken into account. In effect, this is very much the same as the objective reader test that arises from the Bristol & West decision.

The judges then considered the counteraction notices in the particular circumstances relevant to Mr Osmond and Mr Allen and noted that ‘they understood the counteraction notices to assess them to income tax under the TIS regime on the consideration they received for the share buybacks’. Therefore, the appellants ‘were not misled by the omissions in the closure notices, nor confused by them, and they were in no doubt as to what the counteraction notices were intended to achieve’. Similarly, the objective reader of the counteraction notices would clearly have been aware of the information set out in the mini bundles that accompanied those notices. Therefore, both subjectively and objectively the circumstances of Messrs Allen and Osmond were such that the defects in the notices were cured by s 114: ‘The objective reader of the counteraction notices, equipped with their knowledge, could have been in no doubt that the adjustments were being made by way of assessments, and the basis on which those assessments were made.’

Overall, therefore, the tribunal had no difficulty in agreeing that, regardless of any defects in the counteraction notices, they were validly made.

Discussion on validity of counteraction notices

While this case is about counteraction notices, it is clear that the same principles will apply to other notices, determinations, etc. And this is an area where, to be frank, I find myself somewhat conflicted. On the one hand, as an adviser to my clients, I must always be trying to help them find the best outcome. If it appears that HMRC has failed in a statutory requirement in some way, even if this is a purely administrative matter, it is only right that I bring this to my client’s attention and, if appropriate, use HMRC’s error to my client’s advantage. Indeed, Keith Gordon, who appeared for the appellants in this case, has led in some interesting cases based on HMRC’s failures to correctly follow procedure.

On the other hand, speaking as a citizen and taxpayer, it difficult to see why the administration and collection of tax should be quite so dependent on administrative minutiae. Either tax is due, or it is not and, if it is, it should not cease to be due simply because an officer of HMRC filled in a form incorrectly. Or should it? Maybe this is the exact situation that TMA 1970, s 114 was designed to cover (shrugs shoulders helplessly).

On another level, there is an inequality of arms here. There is no taxpayers’ equivalent of s 114, whereby an error in a form, claim, etc does not invalidate it. We are all aware of cases where HMRC have, for example, denied tax reliefs because a form was not submitted on time, or where the taxpayer’s claim was denied for a trivial failure in the qualifying conditions, even though it seems clear that the taxpayer was an obvious target for that relief. It seems somewhat unfair to me that HMRC has a get out of jail free card if it fails to follow procedure, but it will chase innocent taxpayers to the ends of the earth if they so much as misplace a comma in their communications with HMRC.

Final conclusions

I first read the decision in this case at 2 o’clock in the morning after the Taxation Awards dinner in May 2024. Since then, it has spawned a number of very interesting conversations with professional colleagues, as well as a number of articles in the tax press. And we have more to come, given that part of the decision in this case is being appealed to the Upper Tribunal, and there will be further cases looking at the timing of the assessments and the interactions between TMA 1970 and the transactions in securities rules.

On that basis, I hope readers do not conclude that the elements discussed in this last article are in some way of lesser importance, as that is not the case. For those of us who do a lot of work in the transactions in securities area, the question of whether a return of capital falls within the regime has proved difficult in the past.

Most people probably feel this element has now been put to bed following this case, which built on the decision in Bamberg. But there is still some uncertainty about share buy backs. This case, like many of the other cases, relates to a situation where the quantum of share capital has been enhanced by previous reorganisations (usually share exchange transactions), so the amount returned to subscribers, such as the £20m returned to Messrs Osmond and Allen, does not represent the amounts they originally subscribed.

In contrast, I have been involved in a number of cases where there is no such ‘artificial’ enhancement of the share capital, but there is a need to return some of the capital to the shareholders. I am not aware of HMRC challenging the return of capital in any of the cases I worked on. So it does seem that HMRC considers it less offensive to take out capital that was actually subscribed for, in contrast to its approach to cases where the capital taken out has been enhanced by prior share exchanges.

I also think there’s a lot of interesting material around deficiencies in administration, in the discussion on the validity of the counteraction notices. For me, that element of the discussion just serves to highlight the inequality of arms between taxpayers and HMRC. There is no taxpayer equivalent of s 114 to allow minor errors in documentation to be ignored, and it’s not clear whether the tribunals or courts would follow the more contextual approach suggested by the decisions in Bristol & West or Archer and decide in favour of taxpayers.

In the meantime, it is with a little bit of relief that I sign off on this First-tier Tribunal decision and look forward to future decisions in this area.