If we imagine a Venn diagram of two overlapping circles, A and B, and call the overlapping area C, what can we say about the individual areas? Quite clearly, we can say that C forms part of both A and B. But what about the relationship between A and B? Does the partial overlap mean that one forms part of the other? On a natural reading of the words “forms part”, I would have thought not, and HMRC’s argument to the contrary was rebuffed by the First-tier Tribunal in Wilkinson.
A number of individuals proposed to sell their logistics business for a mix of cash and loan notes totalling around £130 million. Two of these individuals were Mr and Mrs Wilkinson who owned 58% of the target company and undertook some capital gains tax planning. At the time of the transaction, entrepreneurs’ relief (now called business asset disposal relief) worked to reduce the capital gains tax rate from 20% to 10% in respect of certain gains (if the relevant conditions were fulfilled) up to a lifetime limit of £10 million (now, the limit is £1 million). Essentially, the CGT planning was to make use of the £30 million aggregate entrepreneurs’ relief lifetime limit of Mr and Mrs Wilkinson’s three daughters. Mr and Mrs Wilkinson gave some of their shares to their daughters (on a no gain/no loss basis) and, on completion, the purchasing entity issued £10 million worth of loan notes to each daughter to be redeemed after the minimum holding period to qualify for entrepreneurs’ relief had expired. The purchaser also issued certain shares to the daughters and they were given directorships to ensure that the conditions for the relief could be met.
In order for Mr and Mrs Wilkinson’s CGT planning to work, it was crucial that the exchange of target shares for loan notes qualified for roll-over treatment under the reorganisation rules (more specifically, under section 135 of the Taxation of Chargeable Gains Act 1992). HMRC argued that the purpose test in section 137 prevented the application of section 135 on the basis that the exchange formed “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”. On HMRC’s view of the world, the “scheme or arrangement” was Mr and Mrs Wilkinson’s CGT planning. The “exchange” was the exchange of all shareholders’ target shares for loan notes in the purchasing entity – including the 42% held by three individuals not concerned in the CGT planning.
So, as with the Venn diagram posited earlier, we have a partial overlap between the scheme/arrangement and the exchange, and the question whether this means that the exchange can be said to “form part” of the scheme/arrangement (as required for section 137 to apply). Quite rightly, in my view, the FTT considered that the exchange did not form part of the CGT planning. Admittedly, the Venn diagram reason (that a partial overlap between two things does not make one of them part of the other) was only a subsidiary reason for the FTT. The primary reason was that the exchange evidently formed part of a different, larger scheme/arrangement – namely, the acquisition of the target by a third party – to which CGT planning was inextricably linked (meaning that it did not exist as a separate scheme in its own right of which the exchange could form part).
But the FTT’s decision does still support the Venn diagram reason; it is also helpful for pouring cold water on the idea that the earlier case of Snell should be regarded as authority that, if part of an exchange forms part of a scheme or arrangement, then the whole exchange should be regarded as forming part of that scheme or arrangement.
Looking at the relevant scheme/arrangement (i.e. the third-party acquisition) here, the FTT decided that avoiding CGT was a purpose (because the deal structure was altered to accommodate Mr and Mrs Wilkinson’s CGT planning), but not a main purpose. The relative size of the tax saving as compared to the total deal value (and to the amount Mr and Mrs Wilkinson stood to receive) and clear evidence that the deal would have gone ahead even if the purchaser had not accommodated the CGT planning played an important part in that conclusion - which seems the right one on the facts.
underlines that the delineation of the scheme or arrangement is often crucial to the application of the purpose test. If the scheme/arrangement had been the CGT planning, I think the taxpayers would almost inevitably have lost. But as the scheme/arrangement was the third-party acquisition, it is hard to see why a comparatively low-value, "nice-to-have" but inessential tax planning associated with (part of) it should change the treatment of the whole deal.