Capital Gains Tax Residence of Companies Inter-Group Disposal Whether Both Companies Resident

SPC00422

Capital gains tax – Residence of companies – Inter-group disposal – Whether both companies resident or both non-resident – Settlements – Gifts to company owned by non-resident trustees – Gains held over – Disposal by company incorporated overseas to subsidiary – Settlors assessed on gain – Whether no gain no loss on inter-group disposal – Central management and control – Anglo-Dutch DTR agreement Art 4(3) - _Place of effective management – TCGA 1992, ss 13, 14(2), 86, 171(1), Sch 5 para 1(3) – Appeals dismissed

THE SPECIAL COMMISSIONERS

Mr RAppellant

- and -

MRS L M HOLDEN

(HM INSPECTOR OF TAXES)Respondent

Mrs RAppellant

- and -

MRS L M HOLDEN

(HM INSPECTOR OF TAXES)Respondent

Special Commissioners:THEODORE WALLACE

DR NUALA BRICE

Sitting in private in London on 1-5 December 2003

John Tallon QC, instructed by a firm of chartered accountants, for the Appellants

Timothy Brennan QC, instructed by the Solicitor of Inland Revenue, for the Respondents

© CROWN COPYRIGHT 2004

1

ANONYMIZED DECISION

1.These appeals arise out of a sophisticated scheme devised on behalf of the Appellants to avoid capital gains tax on the disposal in July 1996 of shares originally held by the Appellants in a business built up by Mr R. The notice of appeal to the Inland Revenue was on 13 November 2001 against closure notices and assessments dated 17 October 2001 following notices of enquiry on 27 January 1999. Notice of hearing was served on the Special Commissioners by the Appellants on 30 May 2002.

2.The appeals concern the liability of the Appellants as settlors to capital gains tax under section 86 of the Taxation of Chargeable Gains Act 1992 in respect of gains treated as accruing to a number of non-resident settlements on the sale of shares which had been given by the Appellants to C Ltd, a company formed by the trustees of the settlements, and transferred by that company to E BV, the gains being attributed to the trustees under section 13.

3.The dispute concerns the applicability of section 171. Mr Tallon contended that both C Ltd (“C Ltd”) and E BV (“E BV”) were non-resident with the result that under section 171, which applied by reason of section 14, no gain accrued on the disposal. The primary dispute concerned the residence of E BV, which was incorporated in the Netherlands and was a wholly-owned subsidiary of C Ltd which was registered in the British Virgin Islands.

4.Mr Tallon’s alternative contention was that if E BV was resident in the United Kingdom then C Ltd was also resident in the United Kingdom.

5.Mr Brennan contended that section 171 did not apply because on a proper analysis of the facts the central management and control of E BV was in the United Kingdom being exercised by Mr R or on his behalf and there was no evidence that C Ltd was resident in the United Kingdom.

6.The capital gains tax on the gifts by the Appellants had been held over. Mr R was assessed under section 86 to £11,149,600 tax on a gain of £27,874,000. Mrs R was assessed to £1,167,881 on a gain of £2,919,700. The appeal hearing was concerned with the issue of liability rather than quantum.

7.It was common ground that if section 171 did not apply the gain on the disposal of shares by C Ltd was assessable on the Appellants by reason of the combined effect of sections 13 and 86 and Schedule 5, paragraph 1(3) of the Taxation of Chargeable Gains Act 1992.

8.At the relevant time section 171(1) provided as follows:

“(1)… where a member of a group of companies disposes of an asset to another member of the group, both members shall … be treated … as if the asset … were acquired for a consideration of such amount as would secure that on the other’s disposal neither a gain nor a loss would accrue to that other …”

Under section 170(2)(a) it is provided that, except as otherwise provided, references to a company in section 171 apply only to companies resident in the United Kingdom. Section 14(2) provides,

“(2)Sections 171 … shall apply in relation to non-resident companies which are members of a non-resident group of companies, as they apply in relation to companies resident in the United Kingdom which are members of a group of companies.”

The evidence

9.The following Statement of Agreed Facts was agreed prior to the hearing:

“1.[GC Ltd] was a trading company operating the [Group Ltd] chain of card shops. [Mr and Mrs R] held 380,920 and 40,000 ordinary shares respectively in the company. These shares formed approximately 96% of the ordinary share capital. Other shares were held by a number of employees and a personal acquaintance of [Mr R], [Mr B].

2.On 27 March 1995 [Mr and Mrs R] engaged [a firm of chartered accountants’ Corporate Finance department] to locate a buyer for the company.

3.On 18 October 1995 [Mr and Mrs R] set up a number of settlements (the [Mr R] Family Settlements Nos 1-8 the [Mrs R] Settlements Nos 1-2 and the [Mr R] Discretionary Settlement). The amount settled on each trust was £1,000. Apart from the Discretionary Settlement, either [Mr or Mrs R] had a life interest in each settlement. The trustee of the 10 life interest settlements was [A Trustees (BVI) Limited] (which changed its name on 6 March 1996 to [Z Private Trust (BVI) Limited)] a wholly owned subsidiary of [Z], who were based in Geneva. [Z] was the trustee of the Discretionary Settlement.

4.On 13 October 1995 the trustees of the above settlements incorporated [C Ltd, a company registered in the British Virgin Islands. The share capital was split into A shares which were held by the interest in possession settlements and B shares which were held by the discretionary settlement. The B shares carried all the rights to the assets of [C Ltd] in the event of a winding up.

5.[GC Holdings Ltd] (formerly [V Limited]) was formed as an off the shelf company on 22 September 1995. The company had an authorised share capital of 100,000 £0.01 ordinary shares. [Mr R] acquired 200 £0.01 ordinary shares on 24 October 1995. A further 90,297 of these shares were allotted to [Mr R] and the remaining 9,503 shares allotted to [Mrs R] on 24 October 1995 for cash.

6.On 24 October 1995 [Mr and Mrs R] gifted 45,248 and 4,751 shares respectively in [Holdings] to C Ltd.

7.On 26 October 1995, [Mr & Mrs R gifted] 380,920 and 40,000 shares respectively in [GC Ltd] to [Holdings]. The chargeable gains arising on the transfers of the shares to [Holdings] were held over under s.165 TCGA 1992.

8.On 27 October 1995, [Mr & Mrs R] gifted 4,525 and 475 shares respectively in [Holdings] to [The R Children’s Trust], a UK resident accumulation and maintenance trust established for the benefit of the children of [Mr R], being [SJR] (date of birth 17 April 1976) and [SRR] (date of birth 19 November 1978). The chargeable gain arising on the transfers into the trust were held over under s.165 TCGA 1992.

9.[C Ltd] purchased from [A BV], a subsidiary of the [Trust Company Bank NV], on 18 July 1996 all the shares in a dormant Dutch incorporated company [E Holding BV]. [Trust Company] was appointed as sole managing director of [E BV] and took an indemnity from [Z].

10.On 23 July 1996 C Ltd disposed of its shareholding in [Holdings] to [E BV] for £23.7 million plus, in the event of a sale within 3 years in excess of that amount, 95% of such excess. A group structure diagram as at August 1996 [was] attached.

11.On 21 October 1996 [E BV] sold its shares in [Holdings] to [Group Limited] for £30,799,384. The other shareholders (both in [Holdings] and the minority shareholders in [GC Ltd]) also sold their shares simultaneously.

12.The following statement (the correctness of which is disputed by the Inland Revenue) was made by way of additional disclosure in the capital gains tax section of the income tax returns of [Mr & Mrs R] for the year ended 5 April 1997.

‘During the year [C Ltd], the BVI company owned by [The R family settlements 1-8] and [Mrs R Family Settlements 1&2] acquired a Dutch incorporated and resident company [ E BV] and sold its [Holdings] shares to [E BV] in exchange for debt. [E BV] subsequently disposed of the [Holdings] shares making a gain which, if it were to be calculated in accordance with UK CGT principles, would amount to around £30,800,000. The entire share capital of [Holdings] was purchased at this time by a third party.

I believe that the disposal of shares in [E BV] does not result in a charge to capital gains tax arising on me by virtue of s 13 TCGA 1992 and/or s 86 TCGA 1992 as [E BV’s] gains are within the charge to Dutch tax (calculated by reference to their principles) and Article 13 of the Anglo/Dutch taxation treaty provides for gains from such property to be taxable in the state where the person making the disposal is resident.’”

The diagram referred to at paragraph 10 of the agreed Statement showed [C Ltd] as owning all the shares in [E BV] which in turn held 49.99 per cent of the shares in [Holdings]. [Mr R] held 40.724 per cent of the shares in [Holdings], [Mrs R] held 4.277 per cent and a trust for their children held 5 per cent. [Holdings] held 96.24 per cent of the shares in [GC Ltd] with [Mr B] holding 1.86 per cent and five other shareholders holding 0.38 per cent each. [GC Ltd] had five wholly-owned subsidiaries.

10.Oral evidence was given by four witnesses:

Witness 1, chartered accountant, who was at the time a partner in the firm of chartered accountants and head of the North West Corporate Finance team;

Witness 2, senior trust manager at Z (Suisse) SA;

Witness 3, solicitor, partner in the firm of solicitors; and

Witness 4, a partner of the firm of chartered accountants.

11.A statement by Nyree Victoria Lane, legal officer, employed in the office of the Solicitor of Inland Revenue, was agreed.

12.A statement by Mr W, of Dutch Trust Company, who was unfit to attend, was not agreed by the Respondent but was admitted in evidence under regulation 17(5) of the Special Commissioners (Jurisdiction and Procedure) Regulations 1994. This is subject to the weight to be given to it.

13.There was a substantial bundle of documents primarily produced by the Appellants but including material obtained by the Respondent from third parties under section 20 notices.

14.In addition to the Agreed Facts, we find the following primary facts.

15.The engagement letter of 27 March 1995 was signed by the two Appellants and followed a meeting between Witness 1, who was head of the North West Corporate Finance team of the firm of chartered accountants, and Mr R who was exploring the market with a view to sale. Profit after tax of GC Ltd was estimated at £7.31 million for 1994/95 and £10.72 million for 1995/96. Sale of all the shares including those held by staff was envisaged. Because the business had been built up by Mr R there was a very large contingent liability to capital gains tax on the Appellants’ shares.

16.The possibility of the transfer of shares owned by the Appellants into trust prior to sale was envisaged in the engagement letter which included the following,

“To the extent that any of your shares are transferred into trust prior to the sale, it is agreed that they will be transferred subject to this letter of engagement.”

Arrangements for tax planning were the subject of a separate letter of engagement from Witness 4 which was not exhibited.

17.Witness 1’s letter included the following,

“We will manage negotiations and advise you on the relative merits of the final offers. During this latter phase, we will assist you in structuring the proposed transaction and in any further negotiations which may be required.

During the final phase of the transaction we will act as the co-ordinating point for you, the purchaser and their respective lawyers to ensure matters are brought to a swift conclusion. This phase of the assignment will include review of contractual documentation and final documentation of tax planning.”

18.Fees were on a sliding scale, with 0.75 per cent up to £100 million as a success fee with a documentation fee and retainer of £75,000 to be deducted. Initially completion was planned for April 1996 in the new tax year.

19.While Witness 1’s team was preparing material and researching potential purchasers, Witness 4 met Mr R on a number of occasions to discuss tax planning.

20.On 11 August 1995 following a meeting Witness 4 wrote a letter of eleven pages including schedules to Mr R confirming details of an off-shore structure under which the Appellants would give their shares in GC Ltd to a new UK resident company in which they would be the only shareholders and they would then give 49.9 per cent of the shares in that new company to a new non-resident company, the shares in which were to be held by the trustees of non-resident settlements established by the Appellants. The gain on the gift of the GC Ltd shares would be held-over and no immediate charge to tax would arise on the sale by the non-resident company of shares in the new UK company.

21.Witness 4’s letter contained a number of other proposals in respect of the trusts and the shares in the new UK company to be retained.

22.The firm of chartered accountants’ charges in respect of the off-shore structure were agreed at £10,000 once the structure was in place and a further £20,000 on sale of the business to an independent third party; legal fees would be extra but should not exceed £3,000 for the off-shore structure. Witness 4 suggested Z (Suisse) as trustees and as directors of the non-resident company and wrote that their fees were normally £2,500 to set up the structure and £2,500 annually.

23.These proposals were duly implemented : see paragraphs 3 to 7 of the Agreed Facts.

24.On 19 October 1995 Z Private Bank & Trust (BVI) Ltd, the sole subscriber to C Ltd, appointed X Nominees Ltd (“X Ltd”), a company incorporated in the British Virgin Islands, as sole director of C Ltd. X Ltd resolved that the shares in C Ltd be issued to the trustees of the eleven settlements. X Ltd resolved that Z (Suisse) S.A. be appointed to provide Corporate Management Services with fees commensurate with the work but not less than 5,000 Swiss francs per annum; Z Bank (Suisse) S.A. were appointed as bankers. A resolution took notice of the fact that X Ltd was “controlled by Z (Suisse) S.A. and/or Z Bank (Suisse) S.A. and/or Z Bank PLC and/or their subsidiaries or associated companies.” It was resolved that the administrative office of C Ltd be x, x, Geneva. That was also the address of Z (Suisse).

25.On 24 October 1995 a series of events occurred. The Appellants sent share certificates in Holdings and transfers by way of gift to C Ltd at Tortola, British Virgin Islands. X Ltd, having tabled letters of gift, resolved to accept them. On the same day X Ltd sent the certificates and transfers back to the directors of Holdings, who were the Appellants, at the address in Rugby of the solicitors who had prepared the settlements. Again on the same day the Appellants as directors of Holdings resolved to approve the transfers and wrote to C Ltd at Tortola enclosing the new share certificates. The result was that C Ltd held 49,999 of the 100,000 shares in Holdings. It is not clear how all of this could have happened on the same day, however it was agreed (paragraph 6 of the Agreed Facts) that the gift of the shares was on 24 October.

26.Meanwhile Witness 1’s team were seeking buyers for the business. Four indicative offers were received by Christmas 1995. One of these was from MV Ltd and NV (together referred to as “MNV”) envisaging acquisition by a newly formed venture capital company; they wished to build on the strengths of the existing management and welcomed continued investment by Mr R. Their indicative offer of £90-100 million assumed an operating profit of £14.5 million in the year to June 1996. The ongoing commitment of key management was viewed as critical.

27.Although trading over Christmas 1995 was disappointing, MNV showed continuing interest. Mr R and his managers made a presentation on 19 January 1996. Following a further visit to GC Ltd a memorandum headed “Re Project Marvel” dated 12 March 1996 by MNV stated that Mr R was genuinely undecided about selling and had no firm personal plans. The memorandum stated, “The business has outgrown his management style but he is loath to let go. It probably requires a firm offer to flush him out.” Later it stated, “The value of the business is unclear.”

28.On 20 March 1996 MNV made an offer subject to contract to the firm of chartered accountants of £85 million, comprising £80 million plus £5 million corporation tax for the current year, on the basis of the selling shareholders re-investing in a 20 per cent share of the institutional investment in loan stock and equity; Mr R would be offered a consultancy agreement; key managers and directors would enter into service agreements. The offer was based on an operating profit of £13 million to June 1996 and was reduced to £75.2 million on 26 April following a reduced operating profit forecast of £11 million.

29.The offer was further modified on 15 May 1996 to £72 million on the basis of the existing shareholders reinvesting one third of the institutional investment and receiving 28.3 per cent of the equity in the new company which was to take over the business and £14.566 million in 15 per cent loan stock; the offer was for 100 per cent of the business.

30.By 16 April 1996 it was intended that a Dutch holding company should be inserted into the off-shore structure (see paragraph 32) and Dutch Trust Company had stated the terms on which it would act. Following a meeting with Mr S at the firm of chartered accountants’ Corporate Finance division, Lovell White Durrant, the solicitors acting for the purchasers wrote to MV Ltd on 26 June 1996 stating among other matters, “We have de facto exclusivity even though they cannot confirm it in writing for tax reasons.” The letter mentioned the tax structure and continued,

“The holding of the [R family] in [Holdings] is held, some direct and some through trusts. About 50% of the trusts onshore and 50% are offshore through the British Virgin Islands. Apparently the structure set up has now been snookered by the last Finance Act and they want to get over the point by interposing a Dutch holding company between the BVI Company and [Holdings].”

“They” in the context referred to the firm of chartered accountants.

31.On 5 July 1996 a letter setting out the terms of engagement for taxation services in relation to Project Marvel was sent by the firm of chartered accountants addressed to the shareholders of Holdings with spaces for Mr R and Z (Suisse) (see paragraph 24 above) to sign. Z (Suisse) was not in fact a shareholder but provided management services to C Ltd which was a shareholder. It is not clear whether it was in fact signed. It covered assistance during the sale of shares in Holdings encompassing “the identification and implementation of strategies, consistent with underlying commercial requirements, for the sale of the shares at an acceptable tax cost.” It provided that only Mr R and Z (Suisse) would have authority to issue the firm of chartered accountants with instructions in relation to Project Marvel and that the firm of chartered accountants should report only to those persons. A fee of £180,000 excluding disbursements would be payable on completion in respect of the fees of the firm of chartered accountants in the UK for “time on the capital gains tax planning aspects … up to completion.” The fee did not include 15,000 Dutch florins for the firm of chartered accountants colleagues in Holland. The letter stated,