Reeves - CGT holdover relief available where transferor is foreign controller of transferee

In Reeves v HMRC [2018] UKUT 293 (TCC), the Upper Tribunal (UT) has held that a non-resident taxpayer was entitled to holdover relief from capital gains tax (CGT) on a disposal he had made when he gifted his interest in a limited liability partnership to a UK-resident company of which he was the sole shareholder.

Background

The issue in the appeal was whether William Reeves (the taxpayer) was entitled, as a non-resident, to claim holdover relief pursuant to section 165, Taxation of Chargeable Gains Act 1992 (TCGA), in relation to a disposal that he made when he gifted his interest in Blue Crest LLP (Blue Crest) to WHR Ltd (WHR), a UK-resident company, of which he was the sole shareholder.

Blue Crest operated a hedge fund business. At the time of the disposal, the taxpayer was resident in the US and was a non-UK resident for tax purposes. A capital gain of some £33.6 million arose on the disposal of the taxpayer's interest in WHR. The gain was chargeable to CGT in the UK as a result of the application of sections 10 and 17, TCGA. The issue was whether holdover relief was available to the taxpayer under section 165, TCGA. The gift had been made in anticipation of the emigration of Blue Crest from the UK to Guernsey in order to avoid the charge which would otherwise have been triggered under section 25, TCGA (deemed disposal by non-resident).

The taxpayer claimed that the gain should be held over and if and when the transferee company disposed of its interest in Blue Crest, it might then have to pay CGT on the capital gain.

Section 167(2), TCGA, dis-applies the entitlement to holdover relief under section 165, where the transferee company is controlled by a person who is neither resident nor ordinarily resident in the UK and is connected with the person making the disposal.

HMRC considered that section 167(2) should be read as including the situation where the transferee company was controlled by a person who was non-resident and who made the disposal. It also argued that the taxpayer's rights could be attributed to his non-resident wife under section 416(2) and (6), Income and Corporation Taxes Act 1988 (ICTA) (since repealed), which provided a definition of "associated company" and "control".

In the taxpayer's view, in considering section 167(2), it was not permissible to attribute his rights and powers to his non-resident wife. To do so would lead to an absurd result as it would make the application of section 167(2) dependent on whether the transferor had non-resident associates.

In the alternative, the taxpayer relied on Article 1, Protocol 1, European Convention on Human Rights (ECHR) (the right to property).

The taxpayer's appeal to the First-tier Tribunal (FTT) was dismissed and he appealed to the UT.

UT decision 

The appeal was allowed

HMRC's case on construction

HMRC submitted that an unintended loophole existed in section 167(2) because the provision only applied when the non-resident controller of the transferee company was a person connected with the transferor, not where the controller was the transferor himself, as in the present case. This, it said, must be a mistake which should be remedied by including additional wording in section 167(2), so that it read:

"A company is within this subsection if it is controlled by a person who, or by persons each of whom, (a) is neither resident nor ordinarily resident in the United Kingdom, and (b) [is the person making the disposal or] is connected with the person making the disposal".

The UT, like the FTT, rejected HMRC's attempt to re-write the legislation, commenting that:

"In our judgment, applying the three-stage test in [Inco Europe Ltd v First Choice Distribution (a firm) [2000] 2 All ER 109], we cannot be abundantly sure what Parliament intended to do about a taxpayer in [the taxpayer's] position, namely one who is a non-resident transferor and who also controls the resident transferee company".

The UT agreed with the taxpayer that section 167(2) was enacted to put an end to the so-called 'envelope trick', which was a widely used arrangement by which UK residents could avoid CGT by gifting their assets to a company controlled by non-resident associates. In the view of the UT, it was not permissible for it to close a different 'loophole' which the provision was clearly not drafted to address.

Section 416 ICTA

Section 288, TCGA, imports the definition of 'control', provided in section 416, into TCGA for all purposes, 'unless the context otherwise requires'. The first issue raised by the taxpayer was whether the context in which the term 'control' is used in section 167(2), TCGA, did require it to be defined in a different way. In agreeing with the taxpayer, the UT concluded that the associate attribution rule in section 416(6) did not have the breadth for which HMRC contended, and the need to draft anti-avoidance provisions widely did not mean that Parliament intended for taxpayers in the taxpayer's situation to be denied holdover relief.

In order to correct the statutory anomaly, the UT said that the modification required was to construe section 167(2) as including the words that were included in section 167(3). It commented:

"We therefore hold that the context of [section 167(2), TCGA] requires that pursuant to [section 288, TCGA], the artificial assumptions to be made … by the attributions of interests between associates within [section 416, ICTA] are limited to connected persons who control the transferee by virtue of holding assets relating to that or any other company".

Human Rights Act 1998 (HRA)

The taxpayer relied on his rights under the ECHR in the event that the UT decided that HMRC's interpretation of section 167(2) was correct and that holdover relief should be denied. It was common ground that Article 1, Protocol 1, ECHR was engaged.

The UT considered whether the provisions in TCGA were discriminatory in treating the taxpayer differently, as a result of his wife and children being non-resident, from how he would be treated if his wife and children were resident in the UK. The UT was of the view that there was clear discrimination on the basis of the taxpayer's status as a person with a non-resident wife and children as compared with a person with a resident wife and children.

HMRC argued that the result in this particular case was not irrational because the taxpayer himself was non-resident. In other words, HMRC argued that the taxpayer should not benefit from holdover relief because he was non-resident. The UT gave this argument short shrift and said:

"We do not regard that as a legitimate point to raise. [The taxpayer], like every other person whether resident or non-resident, is entitled to insist on being taxed only in accordance with the law, including in accordance with his rights under the [ECHR]. It is accepted that [the taxpayer] is properly a 'victim' of the legislation and that the legislation itself does not treat as relevant the status of the transferor; it is only concerned with the residence of those controlling the transferee. One must look at the effect of the legislation more generally not simply in the context of the particular facts of the [taxpayer]".

With regard to whether HMRC had shown that the discriminatory treatment was justified and proportionate, the UT said:

"We accept that although tax avoidance in a broad sense is a legitimate aim of the provision, the literal interpretation of [section 167(2), TCGA] fails on proportionality grounds because of the anomalous position it creates ... In our judgment, it is impossible to justify the application of TCGA 1992, s 167(2) by reference to the residence or non-residence of a spouse who holds no interest in the company to which the gift is being transferred. Indeed, the application of the provision in circumstances where the taxpayer happens to have a relative living abroad strikes us as precisely the kind of provision at which Article 14 in conjunction with [Article 1, Protocol 1, ECHR] is aimed".

In the UT's view, section 167(2) could be read down, pursuant to section 3, HRA, in order to prevent any interference with the taxpayer's rights under the ECHR.

Comment

Although cases of this nature tend to be fact-specific, the way the UT construed the relevant statutory provisions so as to avoid what it considered to be an absurdity arising from a literal interpretation is significant and may have implications for other taxpayers in comparable circumstances. Rather than adopt a literal interpretation, the UT chose to reconstruct the provisions to give effect to what it considered must have been their intended meaning, which was different from the meaning for which HMRC contended.

The UT's decision in respect of the application of human rights law is also significant. It held that the legislation deprived the taxpayer of his possessions, namely, the CGT that he would have to pay if he was unable to claim holdover relief under section 165, TCGA, on a discriminatory basis as his claim for holdover relief would be denied simply because his wife and children were non-UK resident. In the view of the UT, such discrimination was unjustified and disproportionate in circumstances where the taxpayer's wife and children had no interest in the asset being transferred. This decision confirms that taxpayers can, in certain circumstances, rely on their rights under the ECHR to prevent discriminatory or arbitrary results,and tax practitioners should consider whether a decision made by HMRC is susceptible to challenge on this basis.