At first instance, Euromoney had been decided in favour of the taxpayer and my colleague’s post on the decision surmised that “HMRC may be so disheartened by the FTT’s factual findings that they abandon the fight”. This did not come to pass. HMRC appealed the FTT’s decision and the Upper Tribunal has now decided this appeal in favour of the taxpayer.

The taxpayer had proposed to sell its stake in two companies, CNL and CDL. A deal was agreed pursuant to which CNL was to be sold for cash and CDL for cash and shares. The sale of CNL qualified for the substantial shareholding exemption (SSE) in the normal way, but the sale of CDL did not, meaning that a tax charge would have arisen in respect of the cash element of the CDL consideration (with the share element qualifying for roll-over treatment). The tax director of the taxpayer’s parent became involved and suggested replacing that cash element with a preference share issue. The intended result was that the sale of CDL would, as a share-for-share exchange, qualify for roll-over treatment in its entirety. The preference shares could then be redeemed for cash 12 months later with the benefit of SSE. In this way, no tax charge would arise.

HMRC sought to deny roll-over treatment on the basis that “the exchange [forms] part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to capital gains tax or corporation tax” (section 137(1) TCGA 1992). The parties agreed that the “exchange” for these purposes was the exchange of the taxpayer’s stake in CDL for ordinary and preference shares – so, if HMRC had succeeded, roll-over treatment would have been denied in respect of the entire consideration received by the taxpayer for its stake in CDL (and not only in respect of the preference share issue that had replaced the cash element). On this basis, rather than saving £2.8m of tax, the inclusion of the preference shares in the deal would have cost the taxpayer £7.7m.

The FTT approached the application of the purpose test in section 137(1) TCGA 1992 in two steps:

• Was the exchange part of a scheme or arrangements and if so what were they?
• Did the purposes of such scheme or arrangements include the purpose of avoiding a liability to capital gains tax and if so was it a main purpose?

The UT confirmed that this was the correct approach. It rejected – in my view, correctly – a more complicated construction of the statutory provision that HMRC had argued for and which would have involved the FTT in the identification of all schemes of which the exchange could realistically form part (with the result that the purpose test would be failed if tax avoidance was the main purpose of one of the identified candidate schemes).

The two steps involve questions of fact which are for the FTT to determine. The first involves the application of ordinary words of the English language. In respect of the second, the UT confirmed that the purposes of the scheme or arrangements as a whole – and not of individual constituent steps – are the ones that are relevant, but it left open whether identifying the relevant purposes involves an objective or subjective test or a combination of the two (the case had proceeded on the assumption that it was a purely subjective test).

HMRC failed to persuade the UT that the FTT’s factual findings in respect of either step should be disturbed. The UT indicated that HMRC’s contention that the preference share issue (i.e. part of the exchange) should be regarded as the scheme or arrangements does not sit well with the statutory language and, in determining whether the tax avoidance purpose which clearly existed (the taxpayer did not deny that the only reason for the switch from cash to preference shares was the intended tax saving) was one of the main purposes of the scheme/arrangements, the FTT had been entitled to take into account the relative size of the tax advantage in the context of the deal, the taxpayer’s failure to identify the potential downside of jeopardizing roll-over treatment for the entire exchange and the proportion of time and expense spent on the preference share issue.

When commenting on the FTT decision, my colleague stated that the identification of “arrangements” is “a question which has received remarkably little judicial attention”. The UT’s decision does not provide much guidance on this question, either, but it appears to provide a reason why such guidance is scarce – because “There is no substitute for the words of the statute which set out a straightforward test”. As this case shows, the application of this test is not, however, always straightforward…