CGT And Entrepreneur’s Relief: Deciding ‘Main Purpose’
What constitutes a ‘main purpose’ of a transaction for the purpose of avoiding a capital gains tax liability? Companies and majority shareholders ought to note a ruling made in favour of the tax payers who had relied on entrepreneurs’ relief (ER) to avoid CGT. It clarifies the limits to which a transaction might be treated as one for which CGT will arise.
The background to the case1 predates the change from entrepreneur’s relief (under part V Taxation of Chargeable Gains Act 1992) to business asset disposal relief.
A married couple were the major shareholders in a company and transferred some of their shares to their three daughters. Days later, they then sold the company to a third party company, at which point the three daughters received loan notes and shares in that company in a section 135 ‘exchange’. In order to qualify for entrepreneurs relief, the three held the loan notes for a year and a day – then redeemed their nil rate deferred payment A loan notes. The same day, they also sold their shares to a group company at their nominal value.
The conditions of the sale were intended to entitle the daughters to claim ER on their subsequent disposals of the loan notes and shares (which they received in exchange for the shares in their parents’ company). The value of the savings from the CGT planning was approximately £3m.
At issue was whether this formed part of arrangements with ‘the’, or ‘a’ main purpose of CGT avoidance for the purposes of s137 Taxation of Chargeable Gains Act 1992. If it did not, s135 applies (by which the two companies involved in the exchange should be treated as the same company).
The couple argued that s137 did not apply because a main purpose of the exchange was not to avoid CGT. Instead, the main purpose was, for instance to realise the value of their company - the ER secured by their three daughters was not a main purpose of the exchange.
HMRC refuted their arguments saying that the exchange did form part of a scheme or arrangements of which a main purpose was avoidance of liability to CGT. Therefore, s135 did not apply to the exchange and CGT was, therefore, payable by the couple for the year in which the sale took place.
Not ‘main purpose’
The First-tier tax tribunal concluded that though the exchange formed part of a scheme or arrangements to enable the CGT planning, that was not the main purpose of the deal, or even one of its main purposes. The judge clearly had the benefit of copious amounts of contemporaneous documentary and factual evidence about the deal and concluded that:
· The pre-eminent main purpose of the deal was to sell the shares at high value
· The large minority shareholding bloc had no stake in their CGT planning and, in any case, the value of the CGT planning was just 4% of their anticipated proceeds
· While it was obviously important to all five family members that they could obtain ER, it was also clear the deal was going to go ahead even if the intended CGT planning could not be achieved
· The share purchase agreement provided no protection or price adjustment if the CGT planning did not have the desired effect
Note that although earlier clearance from HMRC had been obtained for an earlier proposed transaction, it had not been updated with clearance for the full tax scheme in question. Securing
clearance for a proposed share exchange scheme will negate the risk of HMRC treating an arrangement as constituting tax avoidance - and avoid the expense of this litigation such as this.
Be alert to changes to the various tax reliefs. For example, since the factual background to this case took place, the qualifying period has been increased to two years and the reliefs generally available for CGT have been eroded.
1Wilkinson & Ors v HMRC [2023] UKFTT 00695 (TC)
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