This case has its origins in a complex series of transactions carried out over the period December 1991 to January 1992, and the availability of Export Sales Relief (ESR). The ESR scheme, which predated Manufacturing Relief, provided that profits earned from qualifying exports would be exempt from corporation tax and dividends declared from such profits would also be relieved from income tax in the hands of shareholders. In this case, the transactions under consideration resulted in the ESR reserves becoming available for distribution within a corporate structure which had not been involved in the manufacture and export which resulted in the profits.

The question for the Supreme Court was whether anti-avoidance legislation contained in section 811 of the Taxes Consolidation Act (TCA) 1997 permitted the Revenue Commissioners to form the opinion that the transaction was a tax avoidance transaction and which could be disregarded.

The High Court judgement was covered in the December 2010 issue of tax.point and is also available on tax.point online - http://taxpoint.charteredaccountants.ie

Background

O'Flynn Construction was a company engaged in the construction business. An unrelated company, Mitchelstown Export Company Ltd had accumulated reserves of ESR.

In a series of separate legal transactions O'Flynn Construction Ltd along with another party acquired the ESR reserves from Mitchelstown Export Company Ltd. The result of the acquisition was that O'Flynn Construction Ltd avoided a liability to corporation tax and the shareholders received tax free dividends out of the ESR reserves.

Revenue concluded that the transaction was a tax avoidance transaction and served notices of opinion under section 811 TCA 1997.

The taxpayers appealed the notices before the Appeal Commissioners. The Appeal Commissioners found that the transaction resulted in a tax advantage but it was undertaken so as to benefit from ESR and was not a misuse/abuse of the relief. Therefore the misuse/abuse exclusion, as provided for by section 811, applied and accordingly the transaction was not a tax avoidance transaction within section 811 TCA 1997. Revenue appealed that decision and the case was brought to the Irish High Court.

Disagreeing with the Appeal Commissioners, the High Court held that there had been a misuse of ESR and that the misuse/abuse exclusion was not available and consequently the transaction was a ‘tax avoidance’ transaction.

The taxpayers appealed the decision of the High Court and sought to reinstate the reasoning of the Appeal Commissions. The case was brought to the Supreme Court and the judgment of that court was delivered in December last.

Decision

The Supreme Court, dismissing the taxpayer's appeal by a three-to-two majority, found that the transaction was a tax avoidance transaction within the meaning of section 811 and that the Revenue Commissioners were correct to form that opinion.

The Supreme Court considered that the Appeal Commissioners analysis was too narrow and consequently in error as a matter of law. The statutory phrase, “misuse... or an abuse of the provision having regard to the purposes for which it was provided” was considered to be a “comprehensive indication that the object of the subsection is to ensure that reliefs and benefits are only available to transactions which can be regarded as a proper and intended use of the provision”. Otherwise, the transactions were to be regarded as a misuse or abuse of, in this case, Export Sales Relief.

The Court held that in considering what constitutes a misuse or abuse of the scheme, the Revenue Commissioners are to have regard to the form of the transaction and its substance, whether it was undertaken for the realisation of a profit in the course of business activities, carried out by any person, and finally, whether it was undertaken primarily for purposes other than to give rise to a tax advantage.

The Court held that “the form of the transaction was highly artificial and contrived”. It considered that the transaction was arranged primarily to give rise to a tax advantage, and the substance of the transaction was to pass distributable profits to shareholders, without incurring tax. Such a transaction was “surely a misuse of abuse of the scheme having regard to the purpose for which the provision is provided”.

The full text of judgment of the Supreme Court can be found at http://www.supremecourt.ie/Judgments