How worthwhile are tax clearances?
HM Revenue & Customs is under a legal obligation to consider many different types of clearance. For instance, on a share for share exchange, clearance can be obtained that HMRC accepts the exchange is not occurring for tax avoidance reasons, so that any gain on the disposal of the original shares is not immediately subject to capital gains tax. Likewise, clearance can be requested that, on say a share sale, none of the consideration will be taxed as income by virtue of it being a disguised distribution.
As well as clearances which it is bound to give by law, HMRC will voluntarily give many different types of clearance. For example, it will give advance clearance that the requirements of the EIS (Enterprise Investment Scheme) will be satisfied by a company, thereby giving comfort to would-be investors. Indeed, there is now a general non-statutory clearance procedure under which HMRC will give clearance on most issues not covered by a statutory procedure. But what value is derived by obtaining a clearance?
The obvious answer is that, having obtained a clearance as to how HMRC will tax a transaction, taxpayers are protected from HMRC attempting to tax the transaction in a different way. However, case law has shown that this is not always true. HMRC will only be bound by any clearance it gives if the clearance application satisfied various criteria, eg
- the application needs to set out all the material (or possibly material) facts. In other words the taxpayer has to put all of his cards on the table face upwards. The clearance will not be valid if facts are omitted, or obscured;
- the application needs to be clear about precisely what is being asked for – in particular, if HMRC is being asked to waive an entitlement to tax, this needs to be clear;
- the application needs to set out the taxpayer's legal analysis in full and if an alternative (unfavourable) analysis has occurred to the taxpayer, this should be set out in the application;
- if HMRC gives the clearance, but something in the clearance suggests that HMRC has given it on the basis of a misunderstanding of any kind, the clearance may be invalid unless the position is clarified with HMRC;
- if the facts or the law change after a clearance has been given, HMRC should be asked to reconfirm the clearance – otherwise it may be invalid.
These are hard tests to satisfy. How many clearance applications set out descriptions of the legal reasons why HMRC could reject the clearance? How many clearance applications clearly set out the facts which could persuade HMRC to reject the application? By and large most applications set out a series of facts so innocuous that they reveal nothing which could possibly cause HMRC to refuse the clearance. Therefore, there is little point in obtaining the clearance. The clearance is either unnecessary, if the application truly did set out all the relevant facts and arguments, or it is not binding on HMRC, if the application did not.
The moral is usually only to apply for a clearance when you have a point of genuine concern to clear and, if you do, raise that concern in explicit terms.
Most clearances include asking HMRC to confirm that tax avoidance is not the main purpose ‘or one of the main purposes’ of the transaction. On the face of it, a transaction can only have one main purpose but the courts have not agreed with taxpayers who have argued this. The cases generally show that tax avoidance can be ‘a main purpose’, even though there is another commercial purpose which is ‘the main purpose’. HM Revenue & Customs, in draft guidance which was never finalised, put forward the view that any purpose which is more than incidental is prima facie a main purpose (see Simplifying Unallowable Purpose Tests – a Discussion Document). This may overstate the position but it seems to be the case that any significant purpose of tax avoidance can amount to a main purpose.
This brings us to another question. If a taxpayer enters into a transaction because it produces a tax advantage, is this equivalent to having a main purpose of tax avoidance? For instance, if an investor invests in shares partly because the investment attract EIS reliefs, does this prevent the reliefs from being available?
The short answer is no. Lord Nolan, in the House of Lords’ decision in the case of Inland Revenue Commissioners v Willoughby, said that it would be absurd to describe as tax avoidance the acceptance of an offer of freedom from tax which Parliament has deliberately made. He said that tax avoidance is a course of action designed to conflict with or defeat the evident intention of Parliament. So simply being aware of a tax relief, and undertaking a transaction because of its existence, is not sufficient to render the relief unavailable.
But, again, the value of HMRC confirming that tax avoidance is not a main purpose of a transaction is debatable. By way of example, in Snell v Revenue & Customs Commissioners, Mr Snell failed to secure a tax deferral on a share for loan note exchange because he intended to become non-resident before the loan notes were redeemed (and therefore to escape tax altogether rather than simply defer it). If he had applied for a tax clearance (he did not), HMRC would have given him one unless he had disclosed his intention to emigrate. But it would have been a meaningless clearance because HMRC was not in a position to know that Mr Snell intended to emigrate.
A clearance obtained by failure to disclose the material facts is a security blanket for the taxpayer – comforting, but of no use in a fight!