Rialas – Transfer of assets abroad provisions did not apply
In Rialas v HMRC [2019] UKFTT 520, the First-tier Tribunal (FTT) has found that the transfer of assets abroad (TOAA) provisions did not apply as the taxpayer had not transferred assets to a person abroad .
Background
Mr Andreas Rialas (the taxpayer) was a national of Cyprus, but during the relevant period was resident and ordinarily resident in the UK. He jointly owned Argo Ltd (Argo), a UK company, with Mr Cressman (C). Argo carried on business as an investment adviser. The taxpayer wished to purchase C's 50% shareholding in Argo in order to then dispose of 100% of the shareholding.
In order to facilitate the buy-out of C, a shelf company, Farkland Ltd (Farkland), which was incorporated in the BVI and resident in Cyprus, was acquired. Ownership of Farkland was transferred to a new discretionary family trust, the Rialco trust, which was governed by Cypriot law. The beneficiaries of the Rialco trust were the taxpayer and his family.
Farkland borrowed the purchase price for the shares and entered into a share purchase agreement with C.
C transferred his share in Argo to Farkland, which financed its acquisition with a loan. Thereafter, Argo paid substantial interim dividends to Farkland. The taxpayer and Farkland then sold Argo to a UK listed company.
HMRC issued closure notices assessing the taxpayer to additional income tax on the interim dividends, which HMRC considered was due under the TOAA provisions, originally contained in section 739 et seq, Income and Corporation Taxes Act 1988 (ICTA). This was on the basis that the taxpayer was either the transferor, or had procured the transfer, of assets (the shares), to a person abroad, and he had the power to enjoy the income derived from those assets.
The taxpayer appealed to the FTT.
FTT decision
The appeal was allowed.
The FTT had to determine whether:
1. the taxpayer was the “transferor” within the meaning of section 739, ICTA, and therefore liable to income tax;
2. if the taxpayer was the “transferor” for the purposes of section 739, he was exempted from liability to income tax by section 741, ICTA (the motive defence); and
3. if the taxpayer was the “transferor” for the purposes of section 739 ICTA, the imposition of liability to income tax under section 739 would infringe his right to free movement of capital under Article 56 of the Treaty Establishing the European Union (2002) (the Treaty).
With regard to question 1, HMRC argued that the various actions taken by the taxpayer to establish the relevant acquisition structure, where he effectively "procured" the relevant transfer, made him the “transferor” for the purposes of section 739.
The FTT observed that if C wanted to sell his shares and wanted to obtain the price which he had in mind, then the only option was to sell to the taxpayer, but that did not mean that the taxpayer possessed the necessary influence to dictate whether C should sell his shares, or to whom he should sell them. C was in an equally powerful position to that of the taxpayer, because it was in the taxpayer's interests to ensure that any split between the two was seen to be amicable. Any other outcome would have led to a dramatic fall in share value. The FTT found that it would stretch the meaning of the word procure "beyond breaking point" to suggest that the fact that the taxpayer had organised the acquisition structure meant that he had dictated to whom C should sell his shares. Accordingly, in the view of the FTT, the taxpayer was not the transferor or quasi-transferor, within the meaning of section 739.
The FTT also rejected HMRC's argument that the taxpayer's contribution of 10 Cypriot pounds to the Railco trust amounted to a transfer of assets in circumstances where Farkland had borrowed $15million to finance the acquisition of the shares.
On question 2, the FTT found that the interposition of a non-resident trust between the taxpayer and UK property, namely, the shares in Argo, was motivated by a desire to avoid inheritance tax. The taxpayer would therefore have been unable to rely on the motive defence in section 741, if he had been the transferor.
Finally, with regard to question 3, the FTT held that dividends paid by Argo to Farkland, which would not have been taxed if Farkland had been UK resident, were potentially subject to tax under section 739, because they would be taxable directly on the taxpayer. However, the TOAA provisions in this case contravened the EU rule on the free movement of capital under Article 56 of the EU Treaty.
In the view of the FTT, given the decision in X GmbH v Finanzamt Stuttgart-Korperschaften (C-135/17), the anti-avoidance provisions contained in section 739 were justified. However, as the provisions were penal in nature and not proportionate, they were not compatible with the right to free movement of capital. Since a conforming construction did not achieve the desired result, the only appropriate approach was to dis-apply section 739.
Comment
Not only did the FTT find that the TOAA provisions did not apply in this case, it was also of the view that section 739 was not compatible with Article 56 of the EU Treaty and the free movement of capital. It concluded that its application could not be justified in this instance because it was penal in its effect. In the circumstances of this appeal, it would put the taxpayer in a worse position than he would have been in had he formed Farkland in the UK.
Interestingly, the same judge in this case (Judge Gillett) considered the TOAA provisions in Hoey v HMRC [2019] UKFTT 0489 (TC), a case in which RPC are instructed. The decision in Hoey was released on 29 July 2019, eight days before this decision. In Hoey, Judge Gillett concluded, amongst other things, that the effect of the provisions was simply to put the taxpayer in the same position as he would have been had he entered into an employment contract with a company based in the UK, rather than one based in the Isle of Man. As such, in that case, Judge Gillet concluded that the effect of the TOAA provisions was not penal. Mr Hoey has been granted permission to appeal to the Upper Tribunal.
The decision can be viewed here.