In Hancock & Hancock v HMRC2 the First-tier Tribunal (Tax Chamber) (FTT) has upheld the taxpayer’s appeal against HMRC’s decision that a chargeable gain arose on the redemption of secured discounted loan notes and rejected HMRC’s purposive construction of the relevant legislation.
Mr and Mrs Hancock (the taxpayers) held all the share capital of Bluebeckers Limited, which was sold in August 2000 to Lionheart Holdings Limited (Lionheart). The initial consideration was payable by Lionheart in the form of HSBC bank guaranteed loan notes with provision for payment of further consideration depending on the subsequent performance of the business.
The loan notes were:
- £500,000 A Loan Notes 2007 issued to Mr Hancock;
- £4,137,664 B Loan Notes 2004, which were issued to Mr Hancock; and
- £4,632,336 B Loan Notes 2004, which were issued to Mrs Hancock.
The appeal was concerned with what happened subsequently to the B Loan Notes 2004. These were repayable on 24 August 2004, or at such earlier time as the note holder might require. Clauses in the conditions provided that the note holder could require repayment in US dollars. It was not in dispute that the provision for payment in a currency other than sterling and at an exchange rate other than that prevailing at redemption, prevented the B Loan Notes 2004 from being Qualifying Corporate Bonds (QCBs) for the purposes of section 117 of the Taxation of Chargeable Gains Act 1992 (TCGA).
Additional consideration became payable by Lionheart and was paid on 22 March 2001, as follows:
- £477,516 B Loan Notes 2004, which were issued to Mr Hancock; and
- £477,135 B Loan Notes 2004 which were issued to Mrs Hancock.
On 9 October 2002, deeds of variation removed the right to redemption in US dollars from Loan Notes issued in March 2001. The Revised B Loan Notes 2004 were QCBs within section 117 TCGA.
On 7 May 2003, the B Loan Notes 2004 and the Revised B Loan Notes 2004 were both exchanged for two Secured Discounted Loan Notes 2004 (the Conversion). After this exchange the Secured Discounted Loan Notes 2004 (the Secured Notes) were QCBs within section 117 TCGA.
The Secured Notes provided for redemption on 30 April 2004, or earlier, on certain dates with notice and the loan notes were redeemed on 30 June 2003 together with payment of an associated redemption premium (the Redemption).
The issues arising from the Conversion and Redemption were whether:
- the conversion of the Loan Notes into the Secured Notes was to be treated as a single conversion or two distinct conversions for the purposes of section 116(1) TCGA; and
- on a purposive construction of the relevant provisions and taking a realistic view of the facts, the Conversion and Redemption should be taxed as a single composite transaction (namely redemption of the B Loan Notes 2004 and the Revised B Loan Notes 2004).
Where an asset is a QCB within the meaning of section 117 TCGA, section 115 TCGA provides that a gain arising on the disposal of that asset is not a chargeable gain (and a loss is not an allowable loss).
Different rules are provided for on reorganisations involving QCBs. In broad terms, where the legislation applies, its effect is not to roll over a gain into the QCB, as would be the case under the reorganisation rules, but to freeze the gain that would have accrued on a disposal of the original shares or securities at market value at the time of the reorganisation and to deem the gain as chargeable gain, to accrue on a subsequent disposal of the QCB.
The taxpayers argued that the wording of section 116(1)(b) TCGA meant that the section did not have effect to apply the rules on reorganisations in relation to the conversion of the loan notes into the Secured Notes with the consequence that the gain on the non-QCBs was rolled over into the Secured Notes and was not taxable on a disposal of the Secured Notes on the Redemption.
Section 116(1) TCGA provides:
“(1) This section shall have effect in any case where a transaction occurs of such a description that, apart from the provisions of this section –
- sections 127 to 130 would apply by virtue of any provision of Chapter II of this Part; and
- either the original shares would consist of or include a qualifying corporate bond and the new holding would not, or the original shares would not and the new holding would consist of or include such a bond;
and in paragraph (b) above “the original shares” and “the new holding” have the same meaning as they have for the purposes of sections 127 to 130.”
The FTT concluded that:
- At the date of the restructuring in March 2003, the taxpayers had a settled intention to redeem the Secured Notes with the tax advantage that the restructuring was intended to bring about.
- Given the meaning of “original shares” and “new holdings” within section 126 TCGA (as modified for the purposes of section 132 TCGA) the true construction of section 116(3) and (4) TCGA was to encompass any QCB that formed part of the description “original shares” or “new holding” whether or not there was another asset included within the same description in respect of the same reorganisation or conversion.
The FTT said at paragraph 47 of its decision:
“In our judgment section 116(3) and (4) should be construed so as to apply both where the original shares or the new holding comprised only the QCB, and where the original shares or the new asset merely included a QCB. Only in this way could affect be given to circumstances that section 116(1) makes clear are intended to be governed by section 116. Given the meaning of “original shares” and “new holding” within section 126 … the true construction of section 116(3) and (4) is, in our view, to encompass any QCB that, respectively, forms part of the description “original shares” or “new holding”, whether or not there is another asset included within the same description in respect of the same reorganisation or conversion.”
Therefore, for the purposes of section 116(1)(b), the “original shares” were the B Loan Notes 2004 and the Revised B Loan Notes 2004, and so the “original shares” included the QCB. The “new holding” consisted of a QCB. Accordingly, neither of the conditions contained in section 116(1)(b) were met and accordingly section 116 did not apply.
HMRC had argued that the principles arising from WT Ramsay Ltd v Inland Revenue Commissioners3 and subsequent authorities, including Barclays Mercantile Business Finance Ltd v Mawson4(Inspector of Taxes) , applied in the circumstances of this case in relation to the second issue. With regard to this issue, the FTT considered that the Redemption was not planned and executed by means of the insertion of the intermediate step of conversion into the Secured Notes. The intention to redeem at the particular time at which redemption took place crystallised only in relation to the Secured Notes. The fact that the conversion process was intended to give rise to a tax advantage did not result in the transaction, viewed realistically, being anything other than a redemption of the Secured Notes. Taken in their context, the reorganisation provisions, along with section 116, provided a comprehensive code for the taxation of chargeable gains on reorganisations of securities, conversions, exchanges and reconstructions. A purposive construction of the reorganisation provisions could not produce any different result merely on the basis that the transactions entered into were intended, for tax avoidance reasons, to exploit an anomaly in the application of those rules.
The FTT acknowledged that Parliament could not have intended to allow the non-QCB element of a conversion of securities into QCBs to escape taxation, but concluded that that was the effect of the wording of section 116(1)(b), which was clear and unambiguous. There was a single conversion of the B Loan Notes 2004 and the Revised B Loan Notes 2004 into the Secured Notes.
The FTT was not persuaded by HMRC’s argument that a purposive construction should be applied to the legislation to fill the gap created by the fact that certain circumstances that might have been thought to have been intended to be within the scope of section 116, fell outside of it as a consequence of the clear statutory language contained in section 116(1)(b).
This decision illustrates the limits of purposive construction to tax legislation. HMRC cannot expect to successfully challenge all cases simply because transactions were entered into for tax avoidance reasons.
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