This month’s Chartered Accountants Tax Case Digest takes a look at a case where a gift of an interest in an LLP made to a UK resident company was denied gift relief by HMRC on the basis that the company was “controlled” by non-resident persons connected with the owner of the LLP.

The Upper Tribunal granted the taxpayer’s appeal arguing that it could not be ‘abundantly sure’ about what parliament had intended to do about such a taxpayer who was a non-resident transferor and who also controlled the resident transferee company. The purpose of the anti-avoidance provision at issue in section 167(2) TCGA 1992 had been to prevent UK residents transferring assets to a non-resident company to avoid capital gains tax. It did not address non-resident owners of a limited liability partnership. HMRC could not be allowed ‘to extend a provision designed to close one gap so that it closes a different gap which parliament has not considered’. It is not yet clear if HMRC will appeal this decision.

Background

At the time of the relevant transactions in 2010, Mr Reeves was neither resident nor ordinarily resident in the UK. He was US resident for tax purposes and a 7% partner in an LLP carrying on a hedge fund business in the UK. Mr Reeves, despite being non-resident was within the charge to UK CGT in respect of his partnership share of UK business assets as a result of section 10 TCGA 1992.

The hedge fund had plans to move its business to Guernsey which would effectively remove its assets from the territorial scope of UK CGT. As a result, section 25 TCGA 1992 would have imposed a deemed market value disposal effectively resulting in an exit charge as a result of any latent gain on the chargeable assets of the business at the point of migration.

Before the move, Mr Reeves gifted his 7% partnership interest to a new UK resident company (known as WHR) of which he was the sole shareholder. A claim was made for holdover relief under section 165 TCGA 1992. Because WHR was UK resident, migrating the business no longer removed his 7% share of its assets from the territorial scope of UK CGT meaning no exit charge would arise. Subsequently Mr Reeves sold the shares in WHR without triggering any CGT as he was non-resident and the shares were not a UK business asset (US tax was paid however). It is not clear whether this subsequent disposal was in contemplation when Mr Reeves made the original gift to WHR.

HMRC opened an enquiry into Mr Reeves’ self-assessment tax return for the year ended 5 April 2010. In May 2013 HMRC indicated that they considered the claim to holdover relief invalid because of section 167(2) TCGA 1992. The enquiry was closed on 1 September 2014 and HMRC amended Mr Reeves’ return to disallow section 165 relief effectively subjecting the £33 million gain to UK CGT.

HMRC contended that section 167(2) applied to preclude holdover relief because WHR is “controlled” by non-resident persons connected with Mr Reeves, namely his wife and children. The First Tier Tribunal agreed with HMRC.

Decision

Mr Reeves appealed the decision of the FTT to the Upper Tribunal. HMRC continued to argue that that Mr Reeves was not entitled to holdover relief because relief is denied by the operation of section 167(2) TCGA:-

“167 Gifts to foreign-controlled companies

(1) Section 165(4) shall not apply where the transferee is a company which is within subsection (2) below.

(2) A company is within this subsection if it is controlled by a person who, or by 5 persons each of whom— (a) is neither resident nor ordinarily resident in the United Kingdom, and (b) is connected with the person making the disposal.

(3) For the purposes of subsection (2) above, a person who (either alone or with others) controls a company by virtue of holding assets relating to that or any other 10 company and who is resident or ordinarily resident in the United Kingdom shall be regarded as neither resident nor ordinarily resident there if— (a) he is regarded for the purposes of any double taxation relief arrangements as resident in a territory outside the United Kingdom, and (b) by virtue of the arrangements he would not be liable in the United Kingdom to tax on a gain arising on a disposal of the assets.”

Mr Reeves argued that HMRC was implying words in section 167(3) (namely that the controller has to be someone who controls the company “by virtue of holding assets relating to that or any other company” as being implicit in section 167(2). He also put forward a number of other arguments including that section 167(2) whether construed purposively as HMRC contended or construed literally was a breach of the Treaty on the Functioning of the European Union provisions on the free movement of capital.

His final argument was that he was relying on his rights under the ECHR in the event that the Upper Tribunal decided that the literal interpretation of section 167(2) prevailed meaning that holdover relief was denied if there is a non-resident person connected to the transferor, even if that person has no shareholding or other interest in the company.

The Upper Tribunal in its decision set out that though tax avoidance in a broad sense was a legitimate aim of the provision, the literal interpretation of section 167(2) failed on proportionality grounds because of the anomalous position it created. The Tribunal further set out that it is impossible to justify the application of section 167(2) by reference to the residence or non-residence of a spouse who holds no interest in the company to which the gift is being transferred. The application of the provision in circumstances where the taxpayer happens to have a relative living abroad was, in the Tribunal’s view, precisely the kind of provision at which Article 14 of the ECHR is aimed.

Its application in this manner would be entirely unexpected. No UK resident taxpayer transferring a gift to a company which is wholly owned by other UK resident shareholders would expect to have any difficulty with relying on section 165(4) because of the operation of section 167(2). Nor would any adviser think it necessary to check with his client the tax residence status of all his parents and grandparents, children and grandchildren, brothers and sisters. This would operate as a potential trap for taxpayers and their advisers when trying to plan for the future of their business.

Its application in this way would also be entirely arbitrary because there is no reason why that taxpayer should be treated differently depending on the answers to those questions. In addition, the Tribunal also argued that if HMRC’s interpretation is correct, many taxpayers over the years have claimed holdover relief, without query, when in fact they were not entitled to do so. To interpret the provision in the manner HMRC were seeking to place a discretion in the hands of a taxing authority.

It would also be impossible for the taxpayer to plan his affairs to benefit from the relief in many cases where Parliament clearly intended that he should benefit.

The Tribunal held that Mr Reeves appeal succeeded on the proper construction of section 167(2) meaning section 165 gift relief was available. The Tribunal further held that if HMRC’s literal interpretation of section 167(2) prevailed, this would be an infringement of Mr Reeves’ rights under Article 14 of the ECHR. The legislation would be seen to operate to deprive him of his possessions (namely the tax that he would have to pay because he cannot rely on holdover relief in section 165) on a discriminatory basis, namely because his wife and children are non-resident in the UK rather than resident in the UK. This would be unjustified and disproportionate in circumstances where his wife and children have no interest in the asset the transfer of which has triggered the charge to tax.

The full judgment in this case is available from:- https://assets.publishing.service.gov.uk/media/5bab4f33e5274a54b6245458/William_Reeves_v_HMRC.pdf