Mark McLaughlin warns that structuring transactions in the ‘wrong’ way from a tax perspective proves to be an expensive mistake.
Some taxpayers make the mistake of assuming the tax treatment of an event or transaction where a substantial amount of money is at stake, instead of seeking professional advice, or at least researching the tax implications to the best of their ability.
It is understandable that taxpayers might sometimes respond cynically to tax professionals who recite the mantra about the need to seek expert advice, on the footing that their message is self-serving marketing. However, failure to obtain advice can be costly.
Company acquisition
For example, in Khan v Revenue and Customs (Rev 1) [2021] EWCA Civ 624, the shareholders of a company (CAD) approached the taxpayer (BK) to see if he would be interested in buying the company with a view to winding it up, as there seemed no prospect of finding a buyer and they did not want the burden of closing CAD. BK could not afford to pay for the shares personally, so a share sale and purchase agreement was executed whereby BK bought the entire issued share capital of CAD (i.e., 99 shares) for £1.95 million plus net asset value of £18,771 (i.e., a total of £1.968 million).
Less than 40 minutes later, CAD bought back from BK 98 of CAD’s shares for £1.95 million, which was subsequently paid to the vendor shareholders (NB the £18,771 balance of the purchase price was paid by BK later). So the net effect of these arrangements was:
- The CAD shareholders sold their shares for £1.968 million;
- BK held one share in CAD, at a cost to him of £18,771;
- CAD’s assets were reduced by £1.95 million; and
-
CAD’s issued share capital reduced from 99 shares to one share.
From a tax perspective, the vendor shareholders were liable to capital gains tax on their share disposal; but what was BK’s tax position?
Unexpected (and unfortunate) outcome
HMRC considered that the proceeds received from CAD for the share buyback represented a distribution to BK (i.e., similar to a dividend). BK appealed and put forward several unsuccessful arguments before the tribunals. Finally, at the Court of Appeal, BK argued that ‘entitlement’ to the distribution should be given a wide practical meaning, such that the former shareholders were liable to tax on the distribution (as he had assumed).
Unfortunately, the court concluded that the transactions could not be re-characterised as a buyback arrangement between the vendor shareholders and CAD. The vendors were entitled to the proceeds from the sale of their shares to BK, not to the distribution of £1.95 million in respect of the shares, which CAD bought from him.
The alarming outcome for BK was, therefore, that he ended up with an income tax bill of £594,815 in connection with his acquisition of a company, in respect of the distribution of £1.95 million.
Practical tip
The important message to take away from Khan can be best summed up by the leading judgement in that case: “This is a cautionary tale, which illustrates all too graphically the importance of seeking specialist tax advice before entering into commercial arrangements that might have adverse tax consequences, however remote that risk might appear.”
