Lloyd v Revenue & Customs [2008] UKSPC SPC00672 (11 March 2008) 

Spc00672

TRANSACTIONS IN SECURITIES – whether transaction was carried out for bona fide commercial reasons – yes – whether a main object was to obtain a tax advantage – yes – appeal dismissed

THE SPECIAL COMMISSIONERS

TREVOR G  LLOYD	Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS	Respondents

Special Commissioner: 	DR JOHN F. AVERY JONES CBE

Sitting in public in London on 6 March 2008

The Appellant in person

Andrew Westwood, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	Mr Trevor G Lloyd appeals against a notice dated 9 February 2007 under s 703(3) of the Taxes Act 1988.  The Appellant appeared in person; the Respondent (“the Revenue”) were represented by Mr Andrew Westwood.
2.	The transaction in securities (“the Transaction”) in question is the sale by the Appellant of his 16,333 ordinary shares of £1 in Prosaw Limited (“Prosaw”) to Prosaw Holdings Limited (“Holdings”) on 17 December 2002.  Section 703(1) provides:
“703 Cancellation of tax advantage
(1) Where—
(a) in any such circumstances as are mentioned in section 704, and
(b) in consequence of a transaction in securities or of the combined effect of two or more such transactions,
a person is in a position to obtain, or has obtained, a tax advantage, then unless he shows that the transaction or transactions were carried out either for bona fide commercial reasons or in the ordinary course of making or managing investments, and that none of them had as their main object, or one of their main objects, to enable tax advantages to be obtained, this section shall apply to him in respect of that transaction or those transactions.”
It is common ground that the conditions for the application of s 704 circumstance D are satisfied and that there is a tax advantage.  The issue in this appeal is whether the escape clause at the end of s 703(1) applies.  
3.	There was an agreed statement of facts as follows:
(1)	The transaction
(a)	On 17 December 2002 Mr Lloyd sold his entire shareholding of 16,322 £1 ordinary shares in Prosaw Limited to Holdings for £275,000 paid in cash.
(b)	Immediately prior to the Transaction the issued share capital of Prosaw was made up of 39,044 £1 ordinary shares, 3,627 £1 preferred ordinary shares and 246 £1 preference shares.
(c)	 The issued share capital in Prosaw set out in paragraph (b) above was held as follows immediately prior to the Transaction:
Mr Lloyd	16,322 £1 ordinary shares
Holdings	16,322 £1 ordinary shares
		  3,627 £1 preferred ordinary shares
		     246 £1 preference shares
Mr Crick	  3,200 £1 ordinary shares
Mr Jenner	  3,200 £1 ordinary shares
(d)	At the time of the Transaction Mr Crick and Mr Jenner were directors of Prosaw, having both been appointed to office in January 2000.
(e)	Prosaw paid £312,500 in dividends to Holdings during the accounting period to 31 December 2002.
(f)	At the relevant times, the distributable reserves of the two companies were:
	Prosaw 	Holdings 	
December 2001	£1,273,819	£245,598	
December 2002	£1,039,952	£557,589	
(g)	Mr Lloyd paid Capital Gains Tax on the £275,000 received from the Transaction in the sum of £6,392.40, having had the benefit of various reliefs, including taper relief and retirement relief.
(h)	Mr Lloyd was 50 when the Transaction took place, having reached that age on 28 September 2002.  Retirement relief for Capital Gains Tax was withdrawn at the start of the 2003-2004 tax year.  Mr Lloyd received retirement relief of £125,000.
(2)	Control of the companies
(a)	Mr Lloyd personally held 38.2% of the shares in Prosaw prior to the Transaction
(b)	Holdings held 47% of the shares in Prosaw prior to the Transaction
(c)	Immediately prior to the Transaction the issued share capital of Holdings was £2,000 made up of 2,000 ordinary shares of £1 each.
(d)	The issued share capital of Holdings was held as follows at the time of the Transaction:
Mr Lloyd			1,020 £1 ordinary shares
Mrs Lloyd 			   400 £1 ordinary shares
The Lloyd Family Trust 	   580 £1 ordinary shares
(e)	Accordingly, at the time of the Transaction Mr Lloyd held in excess of 50% of the issued share capital of and was able to control Holdings.
(f)	Mr Lloyd, in holding shares in both Prosaw and Holdings as set out in paragraphs (1)(c) and (2)(d) above, was able to exercise control over both of these companies.
(3)	Tax advantage
(a)	In receiving consideration for the Transaction in the form he did, Mr Lloyd paid Capital Gains Tax of £6,392.40.
(b)	Had Mr Lloyd received his consideration in the form of income, an extra £62,357.60 in income tax would have become due for the tax year ending April 2003, in addition to the amount already paid by Mr Lloyd.
4.	I heard evidence from the Appellant and from Mr Philip Robert Crick and find the following further facts:
(1)	Prosaw is a company manufacturing machine tools.  The Appellant has worked for it for 31 years and has been a shareholder and director for 25 years.  He has an accountancy qualification.  Originally a Mr D J Smith was also a shareholder in Prosaw.  On his retirement in 2000 his shares were purchased by Holdings, which had been formed for the purpose.  The sale included an earn-out based on profits for the following five years and was based on the understanding (or it may have been a condition of the contract, but I did not see the contract) that the Appellant would continue to control Prosaw during that period.
(2)	The Appellant appointed Mr Crick and Mr Gordon Jenner as new directors of Prosaw after Mr Smith’s departure.  At a meeting on 15 September 1999 the Appellant agreed with them in principle that by the end of 2004 they would each have 20 per cent of the ordinary shares, the other shareholdings being the Appellant, 50 per cent, and Barclays Merchant Services, which had financed the purchase of Mr Smith’s shares, 10 per cent.  Profits above an agreed figure were to be shared by the Appellant, Mr Crick and Mr Jenner equally.  
(3)	Based on targets that were set by the Appellant, Messrs Crick and Jenner were each issued with 955 ordinary shares each in Prosaw in July 2000, 1,060 ordinary shares in February 2001, and 1,185 ordinary shares in November 2001.  The shares were issued at par and they were taxed on the additional value as a benefit in kind.  This was expensive for them and they were also expressing concern about being minority shareholders particularly their position in the event of the death of the Appellant.  The uncertainty was affecting their performance.
(4)	At a meeting on 11 April 2002 the Appellant, and Messrs Crick and Jenner made a new agreement in principle that by the start of 2005, when the restrictions relating to the purchase of Mr Smith’s shares were finished, the shares in Prosaw would be held as to one-third each.  Messrs Crick and Jenner would naturally have preferred not to have to wait until 2005.  The manuscript note of the meeting said: “Meadows [the auditors] still working on how.”  The Appellant stated that at this point he took the initiative of working out how to structure the change rather than relying on Meadows, who had been making suggestions that he had not adopted.
(5)	Mr Duncan Childs of Meadows met Mr Geoffrey Charles Joseph Bird, then the local Inspector of Taxes (“the Inspector”), on 16 July 2002 at which they discussed the effect of the share issues to Messrs Crick and Jenner diluting Holdings’ shareholding in Prosaw below 51 per cent on the small companies rate of corporation tax, which meant that SP5/94 no longer applied to exclude Holdings from being treated as an associated company.  The Inspector’s note also stated that Mr Childs was “considering that Trevor Lloyd would sell some of his shares in [Prosaw] to [Holdings]” and that “it was hoped that the 2 new directors would each own a third of Prosaw with Trevor Lloyd owning the other third and [Holdings] would not be required.”  I infer from this, particularly the reference to selling some of the Appellant’s shares, that the Transaction has been thought about but had not yet been decided upon.
(6)	The Appellant discussed with Mr Childs on 16 August 2002 “shares TGL [the Appellant] to PHL [Holdings]” with ?FL [the Appellant’s wife], written below “TGL.” Retirement and taper reliefs were noted and Mr Childs’ note continued “need to confirm no problems for CGT.”  I infer from this that the Transaction was still in course of being finalised.  The reference to the Appellant’s wife, who owned shares in Holdings but not in Prosaw, suggests that the Transaction was being discussed in principle but the details had not been settled.
(7)	In a statement made to the Revenue later the Appellant said that in September 2002 “Meadows suggested suitable plan involving the holding company with two phases of shares movements.”  The Appellant said that the Transaction was his idea and that Mr Childs was to check out its legality and the tax implications (I deal below with whether I find this as a fact).  He also thought that the date could be a month or two earlier.  Based on my inference in the previous paragraph I find that the reference to September was correct.
(8)	Around this time (Mr Crick put it as July 2002 but in view of the above I consider that it may have been in August or September) the Appellant explained the proposal comprising the Transaction and a subsequent purchase of own ordinary shares by Prosaw from Holdings (see below) so as to achieve the aim of equal shareholdings, to Messrs Crick and Jenner who were satisfied by the proposal.  While not legally binding, the Appellant expected to carry out the final step unless the financial circumstances had changed substantially, for example Prosaw was making losses, or if his relationship with Messrs Crick and Jenner had broken down.  He was by then satisfied with the performance of Messrs Crick and Janner and they were not subject to any specific targets.  The agreement of Messrs Crick and Jenner to these proposals was important to the Appellant.  He was concerned that they might leave, and he knew that a rival company had approached one of them.  If they had left, the business of Prosaw would have suffered, particularly as the Appellant was for personal reasons having to spend time away from the business.
(9)	At a further meeting between Mr Childs and the Inspector on 11 October 2002 it was noted that “They had decided what they wanted to do...” and that “before 31 December 2002 Trevor Lloyd will sell his personal holding in [Prosaw] to [Holdings] meaning that the latter company will then own some 85% of [Prosaw].  It was noted that Mr Childs expected that there would be limited tax because of retirement relief, indexation and taper relief.  The Inspector’s note said: “At the end of the earn-out period the plan is that [Prosaw] will buy some of its own shares back from [Holdings] and this will mean that [Prosaw] will then be owned approximately one third each by Trevor Lloyd, P Crick and G Jenner.  This will probably happen in 2005…”  
(10)	In January 2005 Prosaw purchased its own ordinary shares owned by Holdings for about £600,000, leaving Holdings owning the 3,627 preferred ordinary shares and the preference shares in Prosaw.  I was not told the rights of the preferred ordinary shares but I infer that they were similar to the rights of the ordinary shares because the Appellant considered that their ownership by Holdings gave him (together with the other shareholders of Holdings, his wife and a trust) his one-third share.  The shares in Prosaw were then owned approximately one-third each by the three of them (the Appellant, through Holdings, 3,627 preferred ordinary shares and each of Messrs Crick and Jenner 3,200 ordinary shares).
5.	The Appellant contends:
(1)	After the departure of Mr Smith, Prosaw needed to retain the services of Messrs Crick and Jenner and the Appellant had to deal with their concerns about being minority shareholders.
(2)	The Transaction was his idea which demonstrated to Messrs Crick and Jenner that he was doing something to achieve the ultimate goal of equality of shareholdings.  He left the tax consequences to Mr Childs.
(3)	He could have obtained the benefit of retirement relief before it expired in other ways, for example by a transfer to an interest in possession settlement, but this did not meet his commercial objectives.
6.	Mr Westwood, for the Revenue, contends:
(1)	The Transaction did not advance Messrs Crick and Jenner‘s position.  Indeed it was to their disadvantage that the funds of Prosaw were diminished by £275,000 of the dividend of £312,500 that went to pay for the Appellant’s shares in Prosaw.
(2)	The Transaction was unnecessary to achieving the equality of shareholding envisaged for 2005.  There is no logical conection between the two.  Prosaw could have purchased both the Appellant’s and Holdings’ ordinary shares and achieved the same result if the Transaction had not taken place.
(3)	Since the Transaction was unnecessary to achieve the commercial end of equality of shareholdings, the reason for it (and the only object of it) was to obtain the tax advantage.
7.	The issues for me are first whether the Transaction was carried out for bona fide commercial reasons; it is not whether it was a bona fide commercial transaction, which is more objective.  Secondly, whether its main object (or one of its main objects) was to enable the tax advantage to be obtained.  Reasons are subjective reasons why the Transaction was carried out; the object (which I equate with purpose) is what the Transaction hoped to achieve.  In looking at these I am bound to look at the Transaction in its context.  As Fox J said in Clark v IRC [1978] STC 614, 624:
 “In deciding that [whether the transaction was carried out for bona fide commercial reasons], one must, I think look at the transaction in the context of all the circumstances which gave rise to it.  Looked at by itself, the reason for the sale of the Highland shares, from Robin’s point of view, was simply to obtain money.  But one cannot, I think, just look at the sale in isolation.  It must be considered against the background of the facts which gave rise to it and, in particular, of the circumstance which set the whole mater in motion, which was Robin’s intended purchase of Lower Penn Farm.”
8.	In terms of logic, I agree with Mr Westwood that the Transaction was unnecessary to achieving the ultimate goal of equality of shareholdings by 2005.  Messrs Crick and Jenner were in the same position before and after it (except that Prosaw’s funds were reduced by the dividend of £312,500 that was paid only on the preferred ordinary shares owned by Holdings, £275,000 of which went to the Appellant as the purchase price of his shares, with a consequent diminution in value of their shares).  If the Transaction had not taken place, Prosaw could just as well have purchased both the Appellant’s and Holdings’ ordinary shares in Prosaw.  The Appellant was clear that he decided on the Transaction and that Mr Childs merely checked out the tax and legal implications, and that he regarded it as part of the arrangements ultimately leading to the one-third shareholdings of each of them.  I do not doubt the truth of the Appellant’s belief that he decided on the Transaction and that it was part of the arrangements for the ultimate equality of shareholdings.  But I consider that it was more likely that the Transaction was a joint effort with Mr Childs seeing the tax benefits of the Transaction and the Appellant seeing some commercial benefit in putting his shareholding in Prosaw into Holdings as a first step to the goal of equal shareholdings, if only to show that he was doing something to demonstrate that he intended to achieve the ultimate end.  I do not therefore regard it as important who thought of it first.  Messrs Crick and Jenner had the Transaction presented to them as one stage of achieving the ultimate end and they are unlikely to have queried whether the Transaction was a necessary step.  The Transaction had the advantage that Messrs Crick and Jenner saw that something was being done then towards the ultimate end.  Retaining their services was important to Prosaw’s business and was a commercial reason.  The fact that it seems to me today that the Transaction was unnecessary does not mean that the Appellant did not believe that it was, or that Messrs Crick and Jenner did not regard it as a step showing that the ultimate end was being pursued.  Accordingly I find that the Transaction was carried out for bona fide commercial reasons.
9.	On the second issue, whether at least one of the main objects was to enable tax advantages to be obtained, the tax advantage here is that Prosaw funded Holdings’ purchase of the Appellant’s shares in Prosaw for £275,000 out of a dividend of £312,500 which, if it had been paid to the Appellant, would have borne income tax but as a sale of his shares suffered only very limited capital gains tax of £6,392.40 because of retirement relief.  Was one of the main objects in the mind of the Appellant to obtain that tax advantage?  While the Appellant may not have been particularly concerned with tax, Mr Childs must have been and we know from the meeting on 16 August 2002 that the fact that the then current tax year was last opportunity of obtaining retirement relief had been explained to the Appellant.  I have accepted that the Appellant had commercial reasons for carrying out the Transaction and therefore that this was one of his main objects in carrying it out.  The tax treatment of the Transaction was important to the existence and timing of the Transaction.  If the only object was for Holdings to acquire the Appellant’s shares there could have been a share-for-share exchange.  The tax advantage cannot be said to be an effect rather than an object of the Transaction.  I find that the tax advantage was one of the main objects of the Transaction.
10.	Accordingly, I dismiss the appeal in principle.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 11 March 2008

SC 3141/07

Authorities referred to in skeletons and not referred to in the decision:
IRC v Parker (1966) 43 TC 396
Addy v IRC (1975) 51 TC 71
Hasloch v IRC (1971) 47 TC 50
IRC v Brebner (1967) 43 TC 705
IRC v Godwin 50 TC 583