Court of Appeal considers 'main purpose' test and finds in favour of taxpayer

In Delinian Ltd (formerly Euromoney Institutional Investor Plc) v HMRC [2023] EWCA Civ 1281, the Court of Appeal (CA) upheld the Upper Tribunal's (UT) decision, finding that the avoidance of liability to tax was a purpose, but not the main purpose, or one of the main purposes, of the relevant arrangements, for the purposes of section 137(1), Taxation of Chargeable Gains Act 1992 (TCGA).

Background

Delinian Ltd (formerly Euromoney Institutional Investor Plc) (Euromoney) sold it share holding in Capital Data Ltd to Diamond Topco Ltd (DTL). The consideration consisted of the issue of ordinary shares and redeemable preference shares in DTL. The original intention had been that the consideration would be a combination of ordinary shares and cash, but Euromoney suggested the substitution of the preference shares. When the preference shares were redeemed after one year no tax would arise as the disposal would qualify for substantial shareholding exemption (SSE) by virtue of the holding of ordinary shares. The intention was that the entire transaction would be treated as a share for share exchange under section 135, TCGA, with no immediate tax charge. 

Where section 135 applies, an exchange of shares is treated as resulting in neither a gain nor a loss. However, section 135 will not apply, by virtue of section 137(1), TCGA, unless the exchange is effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is the avoidance of capital gains tax (CGT) or corporation tax (CT).

HMRC issued a closure notice denying relief under 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, was the avoidance of liability to CT on chargeable gains, with the result that section 135 was disapplied by section 137(1)) and amended Euromoney's CT return, increasing the amount of CT payable for the accounting period ended 30 September 2015, by £10,483,731.87. Euromoney appealed to the First-tier Tribunal (FTT).

There was no dispute that the exchange of shares was effected for bona fide commercial reasons. The issue between the parties was whether the restriction in section 137(1) applied on the facts of the case.

FTT decision

The appeal was allowed. 

The FTT adopted the approach taken by the High Court in Snell v HMRC [2007] STC 1279, and considered the following: 

(1) was the exchange part of a scheme or arrangements and if so, what were they?

(2) did the purposes of such scheme or arrangements include the purpose of avoiding a liability to CGT and if so, was it a main purpose? 

On the first question, the FTT decided that in order to reflect the reality of the position and in accordance with the wording of the statute, the arrangements must be taken as a whole and should not be limited to the arrangements that concerned only the acquisition of the preference shares in the narrow way argued by HMRC (applying IRC v Brebner [1967] 2 AC 18).

With regard to the second question, the FTT decided that avoiding a liability to CT on chargeable gains was one of the purposes of the arrangements as a whole, because there was no commercial purpose in receiving consideration in the form of preference shares rather than cash. However, on the facts, because the preference share arrangements were not significant in the context of the arrangements as a whole, the FTT decided that avoiding a liability to CT on chargeable gains was a purpose, but not one of the main purposes, of the arrangements. The FTT made several important findings of fact supporting this. The FTT found that tax was not a main driver of the transaction which would have gone ahead in any event  and that Euromoney's subjective intention was focused on the commercial purpose.

HMRC appealed to the UT.

UT decision

The appeal was dismissed. 

Before the UT, HMRC argued that: 

(1) the FTT had applied the wrong test in determining whether the exchange was part of a scheme or arrangements, and what the scheme or arrangements were, for the purposes of section 137(1); and 

(2) the FTT's evaluation of purpose and conclusion that the arrangements did not have a "main purpose" of avoiding a liability to CT was incorrect under the  Edwards v Bairstow [1956] AC 14 principle.

On the first ground, the UT rejected HMRC's argument and held that the FTT was not compelled to focus on any particular aspect of the transaction. Rather, it was for the FTT to decide, as a question of fact, on the scope of any scheme or arrangements in the particular circumstances of the case in line with the ordinary language of section 137(1) and, in doing so, there was no error of approach by the FTT in this instance. Therefore, the FTT was not required to focus on the issuance of the preference shares in substitution for cash combined with a plan for DTL to redeem those preference shares shortly after they qualified for SSE, in the way argued by HMRC.

The UT went on to say that the analysis of whether the main purpose, or one of the main purposes, of the scheme or arrangements was the avoidance of liability to tax required "an examination of the purpose or purposes of the totality of the scheme or arrangements". The UT rejected HMRC's submission that a focus on the purpose of the totality of an exchange or transaction would be unworkable because it would invite a consideration of the subjective purposes of all persons involved in those transactions. 

With regard to the second ground, HMRC argued that, in its evaluation of purpose, the FTT took into account irrelevant considerations, failed to take into account relevant considerations and reached irrational conclusions. The UT rejected this argument and held that the FTT was entitled to conclude as it did, namely, that: 

(1) the relatively modest size of the tax advantage viewed in the context of the deal as a whole was relevant and this suggested that avoidance of tax was not a "main purpose";

(2) Euromoney did not regard the tax advantage as particularly important in the context of the scheme; and

(3) an analysis of the amount of time and expense Euromoney spent on different components of the overall scheme or arrangements had something to say about its belief as to the relative importance of those components. 

Given its conclusions the UT did not feel it necessary to consider the points raised by Euromoney on the basis that, even if those arguments succeeded, it would simply lead to the same overall outcome, but for different reasons. 

HMRC appealed and Euromoney cross-appealed to the CA.

CA judgment

The appeal and cross-appeal were dismissed.

The CA held that, on the proper construction of section 137(1), there are two limbs to the statutory test which requires consideration of whether the entire exchange of shares in question is: (i) effected for bona fide commercial reasons; and (ii) forms part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to CGT or CT. The CA considered that the issue in the present case was solely a matter of statutory construction. 

With regard to the first limb, the CA held that the FTT should determine whether the exchange transaction was effected for bona fide commercial reasons, according to the natural meaning of those words. The CA commented that it cannot be controversial that parties  may enter into a share exchange transaction for bona fide commercial reasons even if that transaction is wholly or partly tax driven. The tax purpose is the subject of inquiry under the second limb, not the first. On the facts of the present case this was not in dispute as it was common ground that the entire exchange was effected for bona fide commercial reasons.  

The CA considered the second limb to be the central issue in the appeal and the question was whether the exchange formed part of a scheme or arrangements of which the main purpose, or one of the main purposes, wass tax avoidance. On this issue, the CA held as follows:

(1) it is not necessary to undertake a free-standing exercise to identify an appropriate or relevant scheme or arrangements from amongst many candidates; the statute is looking for "a scheme or arrangements of which the main purpose, or one of the main purposes, is tax avoidance"; 

(2) whilst it is true that an exchange is qualitatively different from a scheme or arrangements that does not make it a natural use of language to describe an exchange as forming part of a tax avoiding part of an overall scheme or arrangements or even part of an exchange as forming part of an overall scheme or arrangements. Rather, it is a natural use of statutory language to ask whether an exchange (i.e. the entire exchange) forms part of a scheme or arrangements (i.e. the whole scheme or arrangements) of which the, or a main purpose, is tax avoidance; 

(3) the FTT is not required to sift through every permutation or combination of the elements of the scheme or arrangements to see if it can find one, which has as its main, or a main purpose, tax avoidance. If that were allowed the taxpayer may be unable to rely on a statutory deferral of tax liability if a tax avoidance motive existed however minimal in light of the overall scheme for an insignificant part of the arrangements; 

(4) it is not a natural use of language to say that the entire exchange of Euromoney's shares for the ordinary and preference shares in DTL formed part of the scheme to replace the US$21 million cash payment originally agreed with preference shares to the same value, in the way argued by HMRC; and

(5) the CA rejected HMRC's argument that the FTT had made an erroneous enquiry into the relative strengths of the commercial purposes behind the exchange and the tax avoidance purposes behind the other elements of the scheme. 

The CA considered an additional argument relied upon by Euromoney, that taking advantage of the SSE was not tax avoidance and that section 137 was not engaged because the second limb, with its reference to tax avoidance, never arose. This was rejected as the CA held that Euromoney's scheme or arrangements intended to rely on a provision intended to defer tax to secure an outcome where no tax was paid. The meaning of tax avoidance in section 137(1) is clear and if the scheme or arrangements lead to the non-payment of tax that would otherwise have had to be paid, even if deferred, then that is tax avoidance for present purposes. This aspect of Euromoney's cross-appeal was therefore dismissed.  

Overall, the CA considered that parliament's purpose is clear from the language it used and section 137(1) envisages that there may be tax avoidance so long as that is not the sole, or a main, purpose of the scheme or arrangements.  The scheme or arrangements that must be considered are the whole of the scheme or arrangements undertaken, not a selected part or selected parts and the context is crucial in answering this question.

Comment 

This decision provides further helpful guidance on the tribunals' and courts' approach to interpreting the 'main purpose' test in the context of section 137(1), TCGA and is likely to be of wider relevance to the other anti-avoidance provisions contained within the tax code which require an assessment of whether a tax saving is a sole, or main, purpose of a transaction. 

The decision also confirms that the correct approach is to consider multiple contextual factors in deciding if the main purpose, or one of the main purposes, was tax avoidance. The Court rejected HMRC's approach of dissecting elements of a transaction so as to focus on the tax avoiding element only.   

Due to the amount at stake and the important principles involved in this case it will be interesting to see if HMRC seek to appeal to the Supreme Court. 

The judgment can be viewed here.