Spc00699

INCOME TAX – s 703 TA – one of the main objects? – yes – appeal dismissed. 

THE SPECIAL COMMISSIONERS

	MR P A SNELL
	MRS M SNELL	Appellants

-	and –

	HER MAJESTY’S COMMISSIONERS OF
	REVENUE AND CUSTOMS 	Respondents

Commissioner: Richard Barlow	

					 	

Sitting in public in Leeds on 29 February and 24 April 2008.

Mr Timothy Parr of Messrs Horwath Clark Whitehill for the Appellant

Mr Michael Gibbon counsel, instructed by the Solicitor for HM Revenue and Customs for the Respondents 

© CROWN COPYRIGHT 2008

DECISION

1.	In this appeal Mr and Mrs Snell dispute notices, dated 17 July 2006, given under sub-sections (3) and (3A) of section 703 of the Income and Corporation Taxes Act 1988 (the Act) specifying that income tax of £12,500 was assessed from each of them for the year ending 5 April 2002 on the basis that they had obtained a tax advantage that was liable to be counteracted by that assessment by reason of section 703 of the Act.  On 20 June 2006 the tribunal constituted under section 709 of the Act certified in accordance with section 703(10)(b) that there was a prima facie case for proceeding in the matter.

2.	Mr Parr made it clear at the hearing that the sole issue in the appeal is whether or not the tax advantage in question was “one of their main objects” so far as the transactions in question are concerned, as is required by section 703(1) before a tax advantage can be counteracted.  He agreed that the transactions did give rise to a tax advantage and that that was one of their objects so that the issue is whether that tax advantage can properly be held to be one of the main objects of the transactions.  He agreed that the other conditions and circumstances required before section 703 of the Act can apply are all satisfied.  Mr Parr accepted that the burden of proof lies upon the taxpayers so far as that issue is concerned and that in so far as intentions may be relevant the intentions of the taxpayers’ advisors are relevant as well as those of the taxpayers themselves and that in this context consequences of the form of the transaction can be amongst its objects even when they are not part of the taxpayer’s conscious motives.  He also now accepted that the payment in cash, which is the part of the transaction in this case that led directly to the tax advantage, is correctly to be viewed as part of a single transaction rather than as an entirely separate transaction as had been the appellants’ contention at an earlier stage.

3.	The respondents put in issue whether the transaction was carried out for bona fide commercial reasons and assert that one of its main objects was to obtain a tax advantage.

4.	The basic facts are either agreed or are not very much in dispute.  Mr and Mrs Snell had for many years been directors and the sole shareholders of a building company called P A Snell & Co Ltd in which they held all the issued shares, holding 500 each.  The company was a house builder and Mr Snell looked after the management of the building works while Mrs Snell looked after the administration.  Mr and Mrs Snell each gave one share in the company to one of their two sons in 1999 and they hoped their sons would take over the business one day.

5.	I should say that both Mr and Mrs Snell struck me as straightforward people of great integrity.  Necessarily, after the passage of time their recollections are not absolutely precise but I am quite satisfied that their evidence was entirely truthful and reliable so far as they could recall and where they could not remember a fact or date they said so.  I mention this now because the respondents placed great emphasis on possible discrepancies between dates in the documents and the date when transactions actually occurred, though ultimately I think those discrepancies, even if they exist, are of little relevance.

6.	By the summer of 2000 Mr and Mrs Snell were thinking about retirement.  Their elder son was already working in the business and their younger son was expected to join it soon.  The company had considerable assets in excess of £1,400,000.  Mr Snell was concerned that if he and his wife simply passed their shares to their sons they might, in these litigious times, be passing them liabilities as well as assets if a former customer sued the company for some defect in a property and, although no such suits have in fact occurred, that fear gave rise to Mr Snell visiting his solicitor to seek advice.

7.	The solicitor advised Mr Snell that it would be possible to transfer the business to a new company is such a way as to avoid the new company taking on such contingent liabilities as those Mr Snell was worried about.

8.	Following that meeting with his solicitor Mr Snell also enquired of his accountants about making arrangements to transfer the business in the way he envisaged.  It is clear that Mr Snell had no particular knowledge of company law and that is not in the least surprising.  He spoke of wanting to change the name of the company and clearly thought at first that would be all that was required.  

9.	Naturally, at the meeting which took place on 10 January 2001 the accountants proposed a more elaborate arrangement and Mr Judson, the accountant who Mr Snell dealt with, suggested calling in the firm’s tax expert, Mr Parr, because clearly a transaction of the type under discussion, whatever form it might take, would have potential tax consequences.

10.	It was envisaged that a new company would be set up as a holding company and that there would be a trading subsidiary.  The intention was that Mr and Mrs Snell would continue to run the new companies at first and that their elder son would benefit from profits and increased value from the point at which he took over the actual running of the companies.  This would be achieved by creating two classes of shares namely preference shares representing the existing value of the business on the one hand to be held by Mr and Mrs Snell and on the other hand ordinary shares to be held by the elder son, at least from the time he took over the running of the business, representing current and future trading from that date and any profits or increased value created under his management.  At the same time Mr Parr started to think about ways in which Mr and Mrs Snell could receive value in cash from the business which was then retained in the business without incurring capital gains tax.  He had in mind that there might be opportunity to avoid tax by using retirement relief.       

11.	Several variations in the proposals were considered at different times and Mr Parr sought clearance from the Inland Revenue first for a proposal that included Mr and Mrs Snell receiving £180,000 each in cash.  That was based on the retirement relief from capital gains tax then potentially available.  The Capital Gains Clearance Section gave clearance quickly but the Compliance and Collection Division did not respond to a request to give clearance regarding section 703 of the Act in time for the transaction to be completed within the then current tax year.

12.	The proposal was then modified to take account of the reduced level of relief available in the year ending 5 April 2002 and it was proposed that Mr and Mrs Snell would receive £137,000 each in cash.  Again the capital gains clearance was given but the Special Investigation Section refused clearance on 8 May 2001 saying that they were not satisfied that no notice should be given under section 703 of the Act.

13.	Mr Parr advised Mr and Mrs Snell against going ahead with the transaction in the form that included a cash payment of £137,000 and advised that a small amount in cash might be taken.  Mr Parr then attempted to find out what level of cash payment the Inland Revenue would accept was too small to attract a section 703 notice but, not surprisingly, the compliance unit official concerned was not prepared to state a figure.

14.	Mr Parr advised Mr and Mrs Snell on 4 July 2001 that he thought a cash element of between £50,000 and £100,000 would be accepted by the Inland Revenue and subsequently Mr and Mrs Snell opted to take £100,000 in cash (£50,000 each) and on 17 July 2001 the Inland Revenue refused clearance for the option of taking £137,000 cash each that they had anyway, by then or about then, decided not to risk.

15.	The respondents dispute that the transaction giving rise to the new structure of the business occurred on 31 July 2001 which is the date on which the appellants say it occurred.  The respondents do not dispute that the transaction occurred in the tax year ending 5 April 2002 but they say that there is some significance in the fact, if it is a fact, that the transaction did not occur on the dates when they were purported to have been carried out.  I have to say that I cannot see much relevance to that issue.  It seems the respondents suggest that, if the transaction was carried out on a later date than the documents purport to show, then that illustrates the artificiality of the transaction and is relevant to the question whether it was carried out for bona fide commercial reasons. 

16.	In evidence Mr Parr asserted and recollected that the transaction did take place as planned on 31 July but on the other hand there is evidence that the share transfers and other paperwork was delayed.  In particular there was doubt cast on when the payments of cash were made to Mr and Mrs Snell because those amounts were in fact retained in the new company’s directors’ loan account rather than being transferred to Mr and Mrs Snell’s bank accounts but it may well be, and this was the appellants’ recollection, that the reason the amounts were not shown in the records of the movements into and out of the loan accounts until later than 31 July was just that the accountants worked out the figures later.  The loan accounts were used as a source from which Mr and Mrs Snell paid for their living expenses.  They had always left their dividends, so far as possible, in the company via the loan accounts rather than drawing them and paying them into their own accounts so as to allow the company to hold the money so far as possible until they needed it to avoid it going overdrawn.  At the end of the year the accountants would reconcile the loan accounts.

17.	On balance I am satisfied that the transaction was carried out on 31 July 2001.

18.	Taking the description of the elements of the transaction from the agreed statement of facts and confirming the date, which was disputed, the transaction in question took the following form:

On 31 July 2001 (at which time the accumulated profits of P A Snell & Co Ltd were in excess of £1,400,000) Mr P A Snell Mrs M Snell [and their sons] sold their shares in P A Snell & Co Ltd to Snell Group Ltd, a new company incorporated for this purpose for consideration as follows:

An issue of ordinary shares in Snell Group Ltd on a one for one basis.

An issue of £650,000 8.5% non-voting preference shares to each of Mr P A Snell and Mrs M Snell.

A payment of £50,000 cash to each of Mr P A Snell and Mrs M Snell.

P A Snell & Co Ltd ceased trading at the close of business on 31 July 2001 and the trade was transferred to P A Snell & Sons Ltd a new company formed for the purpose being a wholly owned subsidiary of Snell Group Ltd.  P A Snell & Co Ltd was subsequently dissolved.

On 1 August 2001 a dividend equal to the distributable reserves of P A Snell & Co Ltd was paid to Snell Group Ltd.  On that date also P A Snell & Sons Ltd commenced trading.

19.	 At the time that is relevant to this appeal and in so far as is relevant to this appeal section 703(1) read:

“703(1) Where-

…
(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 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.  

20.	The sales of their shares in P A Snell & Co Ltd by the four members of the Snell family were transactions in securities as defined by section 709(2) of the Act and Mr and Mrs Snell obtained a tax advantage in consequence of those sales, so much is not in dispute.  It therefore becomes necessary for the appellants to show that the transactions were carried out for bona fide commercial reasons (it is not suggested that they were in the ordinary course of making or managing investments) and that none of those transactions had as their main object or one of their main objects to obtain a tax advantage.  It is also not disputed that they had as an object obtaining such an advantage.

21.	I hold that the sale of the shares were transactions carried out for bona fide commercial reasons.  These sales were part of the overall transaction which had the effect of securing the continued operation of a successful business in the context of the desire of the owners and managers of that business to retire but to enable the business to continue.  The fact that the owners of the business did not then immediately retire is immaterial.  The transactions also had the bona fide commercial reason that the entrepreneurs who had worked in the business and had built it up were able to take their just rewards for their hard work over the years (mainly in the form of the preference shares in the new company) without preventing the continuation of the business.    

22.	However it is undoubtedly the case that one of the objects of the sale of the shares was to obtain a cash payment for the appellants which gave them a tax advantage and as already noted the sole issue in this appeal, at least as far as the appellants are concerned, is whether that can be said to be one of the main objects of the sale.  The case of Commissioners of Inland Revenue –v- Brebner Tax Cases vol 45 page 705 was cited to me.  That case involved section 28(1) of the Finance Act 1960 which was materially the same as section 703(1) of the Act and the House of Lords held, agreeing with Lord Clyde in the Court of Session, that the Special Commissioners had been right not to look in isolation at part of a transaction involving several elements when considering the question of what was the main object or one of the main objects of a transaction and that an interrelated transaction had to be looked at in its proper setting (see page 713 C-E and 714 F).  That case is also authority for the proposition that it is appropriate to consider that a tax advantage that is ancillary to the main object of a transaction is not one of the main objects (see page 717 G).  However, no further light is there cast on what might be classed as ancillary in this context though I am of the opinion that it means something that is purely incidental and of little importance compared with the other object or objects.

23.	That case is also authority for the proposition that there is a clear distinction between the effect and the object of a transaction.  I take that to mean that however directly a transaction leads to a tax advantage the question whether that was one of its objects is not answered by that clarity of effect (see page 717 F).

24.	In the present case the value of the transaction as a whole was about £1,400,000 and the cash payment was £100,000 (roughly 7%) compared with the issue of preference shares for £1,300,000.  The tax saving was £12,500 each for the appellants.  None of these amounts is trivial and certainly none of them could be described as de minimis as that term is usually understood i.e. too small to be of any legal significance.  I do not think that any sum that was more than de minimis would necessarily be a main object.  Some sums higher than an actual de minimis level would no doubt still be too small to be a main object but that would depend on all the circumstances.

25.	The question remains, is the cash payment so small compared with the total that that cash payment and its tax consequence is correctly to be classed as not one of the main objects of the sale of the shares in P A Snell & Co Ltd.  In my opinion it is not.  I do not consider it to be purely ancillary to the rest of the consideration for the share sale and, although I quite accept that the main object of that sale was to secure the future of the business and that it would not have occurred if it had not been felt to be necessary to secure the future of the business, it is the transaction that actually occurred rather than the original motive for it that has to be judged.  By the time the transaction occurred the cash payment had been decided upon and it does not cease to be a one of the main objects of that transaction just because there is another more important object.  Mr and Mrs Snell made a conscious decision to obtain cash and indeed they chose the highest figure that their advisors were then recommending.  That is in my opinion significant when judging the importance of that object within the transaction.  The Brebner case acknowledged the importance of subjective intentions in this context and so the appellants’ specific intentions are highly relevant (see page 718 E).

26.	The appeal is dismissed accordingly. 

Richard Barlow
Special Commissioner

Release date: 8 July 2008

SC/3138-9/2007