The High Court upheld a decision of a special commissioner that hold-over relief was not applicable to the gift of shares in a private company as part of a capital gains tax avoidance scheme where the transferee company was controlled by a person who was connected with the person making the disposal. In the circumstances of the case the application of s. 167 of the Taxation of Chargeable Gains Act 1992 did not unlawfully restrict the right of establishment contrary to art. 43 EC.

Facts

The taxpayers (a husband and wife) appealed against amendments to their self-assessments in connection with a capital gains tax avoidance scheme involving the gift of shares in a private company, BGF Ltd, to a UK resident company held within an insurance bond issued by an Irish insurance company (IL) that had been taken out by each of the taxpayers and assigned to an Isle of Man company within an Isle of Man settlement. The shares in BGF had been sold in 1998 for £27m.

The Taxation of Chargeable Gains Act 1992, s. 165 gave a hold-over relief for certain gifts. Section 167 restricted the relief in the case of gifts to companies where the transferee was a company controlled by a person who was neither resident nor ordinarily resident in the UK, and was connected with the person making the disposal. Under the relevant provisions of TCGA 1992 any two or more persons acting together to secure or exercise control of a company were treated in relation to that company as connected with one another and with any person acting on the directions of any of them to secure or exercise control of the company.

The taxpayers contended that, even if the tax inspector could show on the facts that the underlying company was controlled by IL and the taxpayers acting together, s. 167 was not satisfied because it was not the case that each of them was neither resident nor ordinarily resident since the taxpayers were resident in the UK; alternatively even if the inspector could show on the facts that the underlying company was controlled solely by the husband, the section was not satisfied because he or she was resident.

The Crown contended that, on the facts, s. 167(2)(b) was satisfied because IL was connected with the taxpayers by virtue of s. 286(7) since they were acting together to secure or exercise control of each of the underlying companies; and the opening words of s. 167(2) were satisfied because IL as 100 per cent shareholder controlled the underlying company within the meaning of the ICTA 1988, s. 416(2). The special commissioner concluded that, on the facts, the taxpayers and IL were acting together to exercise control of the underlying companies. Either on that basis, or on the basis that they acted together to secure control of the underlying companies, the taxpayers and IL were connected persons and s. 167(2) prevented hold-over relief from applying on the gift of shares ((2005) Sp C 462).

The taxpayer appealed to the High Court raising a point of law concerning the compatibility of TCGA 1992, s. 167(2) with art. 43 of the EC Treaty on freedom of establishment.

Issue

Whether the application of s. 167 was unlawful because it restricted the right of establishment of an Irish company contrary to art. 43.

Decision

Lawrence Collins J (dismissing the appeal) said that art. 43 was a fundamental principle of European law, which had direct effect in UK law so that UK legislation had to be read as if a section were incorporated enacting that its provisions were to be without prejudice to the directly enforceable rights of companies incorporated in member states. Freedom of establishment included the right to take up and pursue activities in other member states without discrimination, including the establishment of agencies, branches and subsidiaries. The concept of establishment involved the actual pursuit of an economic activity through a fixed establishment in another member state for an indefinite period. It included the right to set up and manage undertakings in a member state by a national of another state; and a national of a state who had a holding in the capital of a company established in another member state which gave him influence over its decisions and allowed him to determine its activities was exercising his right of establishment.

It was contrary to art. 43 EC for the UK tax legislation to deprive subsidiaries of foreign companies (but not of UK companies) of the benefit of paying dividends to a parent company without having to pay advance corporation tax. So also consortium relief could not be confined to companies controlling, wholly or mainly, subsidiaries whose seats were in the member state in question, because that would be discrimination against companies which had exercised their right of freedom of establishment. A national measure which breached art. 43 in principle had to be shown to be pursuing a legitimate aim which was compatible with the EC Treaty and was justified by pressing reasons of national interest. But it was the right of establishment which had to be restricted for art. 43 to apply. The decisions fell broadly into two categories. The first related to the right of foreign companies to carry on business through subsidiaries without discrimination in a member state (‘Type B transfers’). The second related to the right to establish companies in one member state unhindered by legislation in another member state (‘Type A transfers’). With regard to both types of transfer, the court was concerned with a restriction on the right of a person in one member state to pursue activities through the intermediary of a company or subsidiary in another member state (X, Y v Riksskatteverket (Case C-436/00) [2002] ECR I-10829 considered).

In the present case, the literature accompanying the bonds made it clear that IL did not maintain a permanent place of business in the UK. It referred to another company in the group which was registered in England and to an Irish company with a branch in England, but there was no suggestion that those companies had any connection with the business involved in this case: some fund management activities were said to be carried out by the Irish company but those bonds involved no management by IL. IL was simply participating in a contractual transaction for a fee. The fiscal disadvantage from disallowance of the relief was suffered only by the taxpayer, and the only consequence for companies such as IL was the loss of the fee. In Eurowings Luftverkehrs AG v Finanzamt Dortmund-Unna (Case C-294/97) [1999] ECR I-7447 it was held that giving tax advantages to lessees of aircraft leased by lessors established in that member state and not in respect of leases of aircraft from lessors established in other member states was an unlawful restriction on the right of freedom to provide services under art. 49. But it had not been argued in this case that s. 167 could be a restriction under art. 49 on IL's right to provide the bonds for a fee. The only relevant consequence of s. 167 was that companies in the position of IL would no longer have the opportunity to earn a (modest) fee on schemes of this kind. Taxation provisions might have any number of incidental effects on the ability of financial institutions and professionals established in other member states to charge fees, but that could not of itself engage the right of freedom of establishment. In this case IL's right to freedom of establishment was not engaged.

Chancery Division. Judgment delivered 20 December 2005.