In this issue we look at a recent case on using a capital reduction in connection with a public takeover, as well as examining recent guidance from Companies House and the Investment Association.
REDUCTION OF CAPITAL DID NOT FALL FOUL OF ANTI-AVOIDANCE PROVISIONS
The High Court has held, in Re Home Retail Group plc  EWHC 2072 (Ch), that a reduction of capital which was merely part of a larger arrangement for the takeover of a company was not prohibited by the anti-avoidance provisions of the Companies Act 2006 (the "CA").
A scheme of arrangement is a flexible statutory procedure between a company and its shareholders (or creditors). Schemes can be used for various purposes, including to implement a public company takeover. Indeed, at present, schemes remain the most popular method of carrying out a takeover.
Until recently, it was possible to complete a takeover using a "cancellation scheme". This used a court-sanctioned reduction of capital to remove the target's existing shares and issue new shares to the bidder. Because there was no transfer of the target's shares, no stamp duty was payable.
To address this, the Government amended the CA in March 2015. A new section 641(2A) now prohibits cancellation schemes in the context of a public company takeover.
However, section 641(2B) of the CA contains a limited exception to this prohibition. A company may still use a cancellation scheme to place a new holding company above it.
Home Retail Group plc ("HRG") announced in 2015 that it had agreed to sell its Homebase DIY retail chain, and that, following the sale, it would return capital to its shareholders through a capital reduction. Subsequently, Sainsbury's approached HRG with a view to making a recommended takeover offer.
HRG and Sainsbury's agreed to implement the takeover in three stages:
- A scheme of arrangement would be carried out, under which a new holding company (newco) would be placed above HRG. HRG's shareholders would receive shares in newco.
- Newco would carry out a reduction of capital to return cash to HRG's shareholders.
- The remaining shares in newco would be transferred to Sainsbury's.
HRG asked the court to confirm that the reduction of capital (stage two) was not prohibited.
The court decided that the reduction of capital was not prohibited, because it fell literally within the exception set out in section 641(2B). Its purpose was to place newco above HRG.
The court also considered whether it could apply a non-literal interpretation to section 641(2B). It considered the "Ramsay principle", which can apply to transactions where steps are taken to avoid tax. The general view of Ramsay is that a court should interpret statute in light of its intended purpose and consider whether a transaction, viewed realistically, is one which the statute was intended to apply to.
In the event, the court decided that the reduction formed part of a "real world transaction with a clear commercial and business purpose", and so the Ramsay principle did not apply.
This is a very helpful decision for acquisitive companies and advisers alike.
The decision is not wholly surprising. In this case, the capital reduction was designed merely to interpose a new holding company. The takeover itself was carried out by transferring newco's shares to Sainsbury's, which presumably attracted stamp duty. There appears to have been no advance planning to avoid tax. In particular, the capital reduction was planned before HRG had received the takeover offer from Sainsbury's.
HRG was also helped by the fact that it wrote to HMRC on 13 June 2016 to alert it of the proposed structure, and HMRC responded on 21 June 2016 stating that it had no observations or comments.
The court's willingness to read section 641(2B) literally will give confidence that the exception to the prohibition is robust. It is also encouraging that the court took a sensible and pragmatic approach by looking at the entirety of the transaction to identify its overriding commercial purpose.
However, we wonder whether the decision might have been different if newco had instead been incorporated in a jurisdiction where no tax is payable on share transfers, such as the Isle of Man, or indeed, in another jurisdiction, but not in the UK where stamp duty is payable.
In those circumstances, if there is no other link to the overseas jurisdiction, the sole or primary purpose of the capital reduction might well be viewed as interposing a holding company specifically in order to avoid paying stamp duty in the UK. It may be that the courts would be more prepared to invoke the Ramsay principle and prohibit a cancellation scheme in such a structure.
COMPANIES HOUSE GUIDANCE ON CONFIRMATION STATEMENTS
Companies House has updated its guidance on submitting annual confirmation statements. The revised guidance can be found here.
Broadly, it explains that, if a company is submitting its first confirmation statement and it hasn't already submitted a statement of capital in the new style, it must submit a full statement of capital with the confirmation statement. This is because the company will not have provided the aggregate amount unpaid on the total capital of the company in any previous statements of capital.
We are also aware of on-going obstacles to submitting confirmation statements electronically to Companies House where there have been historic changes to a company's PSC register.
As always, the best starting point for a company is to compile its confirmation as early as possible to avoid these potential pitfalls.
INVESTMENT ASSOCIATION GUIDELINES ON VIABILITY STATEMENTS
Since 1 October 2014, the UK Corporate Governance Code (the "Code") has required companies with a premium listing to produce a longer-term "viability statement". The statement must set out how the directors have assessed the company's ongoing viability and prospects and over what period.
As with all other provisions of the Code, a premium-listed company is required by Listing Rule 9.8.6 to state whether it has complied with this provision.
The Investment Association has published guidelines setting out institutional investors' expectations for viability statements. They can be found here. In particular, they make the following recommendations:
- The period covered by the viability statement should be "significantly longer than 12 months". Directors should select the most appropriate period. Most have adopted a three-year time frame, with some utilities and property companies opting for five years.
- Directors should be clear why they have selected a particular timeframe and how they have considered wider factors in determining that timeframe.
- Companies should distinguish time horizons for prospects and viability. For example, they may have a long-term strategy looking forward over 20 years, a medium-term business plan covering five years and a short-term budget for the following year.
- Viability statements should address the sustainability of dividends, prioritise identified risks and how they will be managed, and explain any stress-testing that underlies their content.
- They should also distinguish between risks that impact performance and those that threaten the company's day-today operations and existence. The latter are suitable for a viability statement.