Following a disclosure by a bank (now confirmed as Barclays) HMRC, on 27 February 2012, published proposed new legislation aimed at closing loopholes in the rules in the loan relationship legislation dealing with the buy-back of impaired debt by connected companies (also known as the "deemed release" rules).
The proposed new legislation, which will be introduced in Finance Bill 2012, seeks not only to amend the legislation to remove the loophole, but also introduces a new widely drawn targeted anti avoidance rule (a "TAAR"). Finally, and unusually, retrospective legislation is also introduced to ensure that the disclosed scheme itself fails to achieve the anticipated tax benefit.
The changes serve as a useful reminder to taxpayers that, in certain circumstances, HMRC may respond to disclosed schemes by putting forward wide and possibly retrospective legislation to thwart taxpayers and render ineffective disclosed schemes. The risk of such a response is heightened where the Government has already attempted to legislate to prevent similar avoidance schemes, and/or where there are wider political considerations. It is also interesting to see HMRC's continued use of TAARs in legislation notwithstanding the on-going debate on the introduction of a General Anti Avoidance Rule ("GAAR").
Other legislative changes were introduced at the same time to render ineffective a scheme that sought to exploit the provisions of the Authorised Investment Fund regulations to generate a repayment of tax.
A link to the draft legislation on the "deemed release" rules and the Authorised Investment Fund rules can be found here.
The "deemed release" rules are discussed in more detail below.
Introduction
Following a disclosure by a bank (now confirmed as Barclays) HMRC, on 27 February 2012, published proposed new legislation aimed at closing loopholes in the rules in the loan relationship legislation dealing with the buy-back of impaired debt by connected companies (also known as the "deemed release" rules).
The proposed new legislation, which will be introduced in Finance Bill 2012, seeks not only to amend the legislation to remove the loophole, but also introduces a new widely drawn TAAR. Finally, and unusually, retrospective legislation is also introduced to ensure that the disclosed scheme itself fails to achieve the anticipated tax benefit. Comments on the new legislation are invited by 12 March 2012.
At the same time legislation was introduced (by way of statutory instrument) preventing corporate taxpayers from exploiting the provisions in the Authorised Investment Fund regulations to obtain tax benefits on distributions where there has been no taxation of the underlying income giving rise to the distribution. The technical background to these changes is not discussed further in this briefing but the legislation can be found here.
Legislative background
In brief, where a debtor company buys back its own impaired debt (for less than the carrying value in the debtor's accounts) from a third party unconnected creditor, the general rule is that the debtor and creditor will be taxed in line with their accounting treatment. The debtor company will realise a profit, and be taxed accordingly. Similarly, where debts are released, a debtor company would usually realise an accounting profit and be subject to tax on that profit save that releases between connected companies are generally tax neutral for creditor and debtor.
Historically companies wishing to buy back their own impaired debt have sought to use the connected company rules to structure buy-backs in such a way as to avoid any tax charge, essentially by having a group company other than the debtor buy back the impaired debt and then releasing that debt (taking advantage of the connected company rules) to avoid tax on the profit arising to the debtor.
HMRC had recognised the potential asymmetry in tax treatment caused by such structures (the original creditor receiving a tax deduction, without a corresponding charge for the debtor), and therefore in 2005 introduced "deemed release" rules to tax the debtor companies where impaired debt was first acquired by a connected company. However there were wide exemptions which meant, in practice, it was unusual for any debtor company to suffer tax on a buy-back of impaired debt.
These rules were tightened in 20091 and subsequently, so that it became far more difficult to structure a buy-back of such debt without triggering a charge for the debtor company. The rules do though remain relatively formulaic and prescriptive, as a number of clearly defined conditions have to be met at the relevant time before one or other of the deemed release provisions would apply.
The debt buy-back scheme and new legislation
Under a scheme disclosed to HMRC, a debt buy-back was structured so that the debt (trading at a discount) could be bought back by an unconnected company and then released after that company became connected with the debtor without triggering a tax charge for the debtor company.
Once enacted the legislation will render the disclosed scheme ineffective whether implemented in the future or on or after 1 December 2011. The TAAR is effective from 27 February 2012 and will prevent the avoidance of a charge to tax under the deemed release rules where "the main purpose, or one of the main purposes, of any party entering into them (or any part of them)" is to avoid or reduce a deemed release charge.
For a full description of the scheme itself and the changes to the deemed release rules see the HMRC draft legislation and explanatory note (http://www.hmrc.gov.uk/drafts/ct-loan-technote.pdf).
Comment
Contrary to some of the wider press coverage on the point, the activities of the bank (the buy-back) appear to have been commercially motivated. This appears to be an example of a taxpayer carrying out a commercially motivated transaction in a tax efficient manner, rather than a transaction carried out solely or principally to achieve a tax advantage, and then disclosing that transaction to HMRC.
Nonetheless, it is clear (from the legislative history) that this is an area where HMRC have, albeit not entirely successfully, attempted to legislate to close many mitigation opportunities available to debtor tax payers. It is against this background, and also the fact that the bank concerned had signed up to the Banking Code of Practice on Taxation (the "Code"), that HMRC have introduced the legislative changes including retrospective changes. For further details on the Code, see the Herbert Smith briefing from July 2009.
Retrospective legislation
As noted the introduction of retrospective legislation, aimed at rendering ineffective an already implemented scheme, is relatively unusual.
That said, unsurprisingly, the risks of retrospective legislation appear to be increased where the Government has already legislated (albeit imperfectly) to prevent taxpayers from obtaining the very benefit that a new scheme attempts to obtain. The risk is further increased where the beneficiaries of the scheme are already the focus of political attention and pressure. In light of this, and the fact that the bank concerned was a signatory to the Code, the retrospective nature of this legislation is perhaps not as surprising as it may at first appear.
Whilst the retrospective legislation is clearly targeted at the bank concerned, the legislation would apply equally to any other taxpayers who have implemented a similar scheme after 1 December 2011.
If there are such other taxpayers they will now need to consider their position, including whether there is any possibility of judicially reviewing the new legislation as it applies to them (on the basis, for example, of an infringement of the taxpayer's human rights or EU law).
However the recent Court of Appeal decisions in Huitson and Shiner indicate that taxpayers may well have an uphill battle seeking to judicially review this new legislation. In particular the Government would be likely to argue that (through legislative changes in 2009 and later) it has clearly indicated that it intends that a debtor company should (other than in certain prescribed circumstances) suffer a tax charge on a buy-back of impaired debt. On that basis, any Court may well conclude that taxpayers should have been aware that any scheme that sought to achieve a different tax outcome could be open to attack, including by means of retrospective legislation, and that their human rights2 or EU rights have not been breached as a result of such legislation.
Our Tax Disputes group will shortly be publishing a separate briefing dealing specifically with Huitson and Shiner.
TAARs and GAARs
The new TAAR is widely drawn when compared to, say, the proposed TAARs in the new Controlled Foreign Company legislation. In particular, the fact that planning will fail where a main purpose of any part of arrangements ("arrangements" itself widely defined) is to reduce the tax charge goes beyond the usual TAAR drafting.
The risk with such wide drafting is that it could catch commercially motivated transactions which are (for example) structured so as to fall within the express exemptions to the deemed release rules. It is assumed that is not HMRC's intention, as otherwise taxpayers could find that the effect of the TAAR was that the exemptions could only be obtained "accidentally" (ie, by a taxpayer who does not structure or carry out debt buy-backs with the exemptions in mind). We do not believe that this is how any such TAAR would be implemented (or how, purposively, it would be interpreted) but it is unfortunate that the drafting of the TAAR is sufficiently wide as to leave advisers and their clients having to consider the point.
Ideally the scope of the TAAR will be narrowed so as to make clear that structuring to fall within the express exemptions will not fall foul of the TAAR. Alternatively it may be that the TAAR remains widely drafted, but that the scope is clarified through further HMRC guidance. Whilst additional guidance would reduce any uncertainty, the preference must be for accurately drafted legislation, as opposed to taxation (or forgiveness of taxation) based on HMRC guidance alone. It remains true that a taxpayer should "be taxed by law and not be untaxed by concession"3.
This new TAAR has been introduced against the backdrop of the continuing debate on (and expected enactment of) a GAAR. It is interesting to note that it is by no means certain that the disclosed scheme would have been caught by the form of GAAR recently proposed by the Study Group led by Graham Aaronson QC. This perhaps says more about the difficulties in framing a GAAR in a way that provides taxpayers or HMRC with any degree of certainty than about this particular scheme.
It does though seem fair to assume that, whether or not a GAAR is introduced, HMRC will continue to push for TAARs in areas where they believe that opportunities for avoidance exist.
Conclusions
There are a number of interesting issues that arise from what at first may seem a relatively technical change to tax legislation. HMRC's response highlights that taxpayers and their advisers should always bear in mind that legislation may be introduced retrospectively to counter their particular scheme, and also highlights some of the factors that may be relevant when assessing the likelihood of such a response. It is also interesting to observe that HMRC continues to introduce often widely drawn TAARs into new and existing legislation – perhaps demonstrating that HMRC, as much as taxpayers, remain unsure as to the scope or effectiveness of any new GAAR.
