Mark McLaughlin highlights the importance of ensuring that business contracts and agreements are drafted carefully to avoid unexpected and expensive tax consequences.
Contracts and agreements sometimes state one thing but mean another. When a taxpayer asks HM Revenue and Customs (HMRC) to treat an event or transaction as the parties intended, as opposed to in an unintentional way based on an inaccurately or imprecisely drafted contract or agreement, HMRC’s response is invariably that the tax treatment must follow the terms of the contract or agreement, even when the tax consequences are unexpected and more costly to the taxpayer.
Business sale agreements
Thus, on (say) a company sale, the share sale and purchase agreement (SPA) should be drafted carefully to reflect the intended rights and obligations of the parties under the agreement and prevent unforeseen and unexpected tax liabilities. For example, in McEnroe and Newman v Revenue and Customs [2023] UKUT 225 (TCC), the taxpayers sold a company (KCPL), in which they were both 50% shareholders. The SPA stated that the consideration for the shares was £8m. KCPL owed approximately £1.1m to Allied Irish Bank (AIB). On the day of sale, the buyer’s solicitors transferred £8m to the taxpayer’s solicitors, who transferred funds to AIB to redeem the loan owed by KCPL. After payments of professional fees by the taxpayers’ solicitors, the taxpayers each received just over £3.3m.
The taxpayers submitted tax returns showing consideration for the shares as 50% of £6.9m (plus an ‘earn-out’ received later). HMRC contended that the consideration should be 50% of £8m (plus the earn-outs). The taxpayers appealed, arguing that the proper construction of the SPA was that the buyer paid some £6.9m for the shares and circa £1.1m to repay the bank debt. However, the First-tier Tribunal (FTT) considered that the SPA was very clear. Whilst accepting that the sellers received £6.9m, not £8m, it did not follow that they were not entitled to £8m under the contract. On the subsequent appeal, the taxpayers’ representative referred the Upper Tribunal (UT) to a clause of the SPA (clause 3.3), which stated that the consideration would be adjusted when the completion accounts were prepared. However, the UT found that the taxpayers and HMRC had not argued before the FTT that clause 3.3 adjusted the consideration. Thus, the UT found it reasonable for the FTT not to have considered the possibility of any such adjustment to the consideration under the terms of clause 3.3 of the SPA. The taxpayers’ appeal failed.
A different outcome
The outcome for the taxpayers in McEnroe and Newman might have been different if the SPA had stated that the consideration for the shares was £6.9m, and the buyer had separately agreed to inject £1.1m into KCPL to enable the bank debt to be discharged. This would potentially have saved the taxpayers capital gains tax on £1.1m.
In addition, the buyer presumably paid stamp duty of £40,000 for the shares based on consideration of £8m. By structuring the transaction differently, such that consideration for the shares was £6.9m instead (on which the stamp duty liability would have been £34,500), the buyer could have achieved a stamp duty saving of £5,500.
Practical tip
HMRC will generally seek to tax a transaction according to the terms of the relevant contract or agreement; so, make sure that the wording accurately reflects what is intended to happen, and seek professional advice when needed.
