Tax Avoidance Scheme – notification

Introduction

This Special Commissioner decision dealt with the requirement of a promoter of a tax scheme to notify HMRC of the scheme. A key aspect of the decision was the analysis of the condition that the scheme must involve the “inclusion” of shares before it was notifiable, and in particular how wide the meaning of “inclusion” should be.

This decision dealt with the old Regulations (which were replaced in 2006)

The Facts

Mercury Tax Group (“Mercury”) was the promoter of a tax scheme.

In summary, the scheme involved high income individuals forming a Jersey limited partnership (Liberty 1) for carrying on a financial trade and contributing capital equal to the tax loss they wish to create. An offshore parent company (SPV1) had a subsidiary (SPV2). SPV2 declared a large dividend out of its share premium account. SPV1 sold the right to the dividend to Liberty 1 for an amount equal to the dividend, which was paid for by the partners’ contributions, following which Liberty 1 received the dividend. The scheme was said to work because a particular section of the Taxes Act 1988 provided that the seller of the right to the dividend (SPV1) was taxable on it and not the recipient (Liberty 1), while the cost of purchasing the dividend was deductible on general principles as being in expenditure incurred in the course of the financial trade of Liberty 1.

The scheme was not notified within the relevant time limit which expired on or before 2 February 2006. It was voluntarily notified in September 2006 after the Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2006 came into force on 1 August 2006, but before it had been used after that date.

The Issue

The issue in this Special Commissioner's decision was whether the scheme was notifiable within the Regulations (which have been superseded by 2006 Regulations).

The Decision

According to the legislation, “notifiable arrangements” meant any arrangements which—

1. fall within any description prescribed by the Treasury by regulations,
2. enable, or might be expected to enable, any person to obtain an advantage in relation to any tax that is so prescribed in relation to arrangements of that description, and
3. are such that the main benefit, or one of the main benefits, that might be expected to arise from the arrangements is the obtaining of that advantage.

It was common ground that (b) and (c) are satisfied, and that Mercury was a promoter and was under an obligation to notify the arrangements if (a) was satisfied.

Mercury obtained Counsel's opinion that the scheme was not notifiable.

Revenue Contention

• There was no doubt that the scheme included shares.
• The Regulations were drafted in the widest possible manner by reference to widely-defined characteristics because the Regulations had to cover tax avoidance schemes that by definition were unknown to HMRC.
• Without the inclusion of the shares in SPV2 as part of the arrangements no tax advantage could ever have been obtained.
• It was irrelevant that there was no transaction in the shares; the test was whether it was the inclusion of the shares in the scheme that gave rise to the tax advantage.
• Even though the names of individuals using the scheme were now known to HMRC the maximum penalty should be payable as HMRC lost time in which the scheme could have been legislated against.

Mercury Contention

• The scheme involved the purchase of the right to a dividend, which was not within the definition of a financial product in para 7 of the Regulations.
• Based on the wording of the Regulations, a dividend was separate from securities.
• A dividend was a different asset from a share. It was but one of the bundle of rights that characterised a share.
• Although Mercury took the view that the scheme was not notifiable it took Counsel's opinion and behaved in a responsible manner.
• If Mercury were wrong they should not suffer any penalty in the absence of clear guidance having taken Counsel's opinion.

The Special Commissioner stated that he did not find the Regulations easy to interpret.

According to the Special Commissioner, there were two conditions:

1. that the arrangements included one or more of the financial products to which para 7 applies, and
2. that the tax advantage expected to be obtained under the arrangements arises, to a significant degree, from the inclusion in those arrangements of the financial product (or any of the financial products) to which para 7 applied.

It was decided that Condition (1) was satisfied-it could not be said that the arrangements did not include a share when one party to the arrangements, SPV1 held, and was required to continue to hold the shares of SPV2.

On the other hand, condition (2) was found to be more difficult to apply-did the expected tax advantage arise from the inclusion of a share in the arrangements, or from something else?

The following quote provides the Special Commissioner's reasoning: “The more proximate cause of the expected tax advantage is the purchase of the right to the dividend. The inclusion of the share in the arrangements is much more a “but for” cause, that but for the inclusion of the share there would be no dividend and therefore no expected tax advantage. I consider that the Regulation is looking at the proximate cause of the expected tax advantage, which is not therefore from the inclusion of a share in the arrangements.”

It was decided that condition (2) was not satisfied and so the scheme was not notifiable and so there could be no penalty.

The judgment is available online at http://www.bailii.org/uk/cases/UKSC/2009/SPC00737.html.