UK: Weekly Tax Update - Monday 24 October 2011

Last Updated: 28 October 2011
Article by Richard Mannion

1. Private Clients

1.1. HM Treasury confirms ISA limits for 2012-13

Following the publication of inflation figures for September, HM Treasury has announced that subscription limits for Individual Savings Accounts (ISAs) from April 2012 will increase to £11,280 (up to half of which can be saved in cash).

The Junior ISA annual subscription limit of £3,600 (available from 1 November) and the Child Trust Fund annual savings limit (with an increased of limit of £3,600 from 1 November) will be index linked from April 2013.

1.2. Davies and another and Gaines-Cooper

The Supreme Court has decided for HMRC in dismissing the appeals from three taxpayers including Robert Gaines–Cooper that reliance could be placed on specific parts of the guidance on residence in the booklet IR20 alone for determining their residence status for tax.

The leading judgment for HMRC was given by Lord Wilson who was of the opinion that the guidance in IR20 set out only the main factors to be taken into account when considering the residence status of an individual, and that a decision could only be made on an evaluation of the facts of the case. He said:

"The preface to the booklet stated:

"The notes in this booklet reflect the law and practice at October 1999. They are not binding in law and do not affect rights of appeal about your own tax.

You should bear in mind that the booklet offers general guidance on how the rules apply, but whether the guidance is appropriate in a particular case will depend on all the facts of that case. If you have any difficulty in applying the rules in your own case, you should consult an Inland Revenue Tax Office..."

The first paragraph quoted does not advance the Revenue's case: no doubt it intended the booklet to reflect the law but it accepts that, were the booklet to have failed to do so, it would be bound by its terms irrespective of the discrepancy. The second paragraph is however of greater significance: it stressed that the guidance was general; that its application to a particular case depended upon its facts; and that, in the event of any difficulties in its application to his case, the individual should consult a Revenue tax office. Neither in 1976 nor at any time thereafter did the second appellant seek advice from a tax office, still less a ruling on residence such as was available until the introduction of self-assessment on 6 April 1996. Nor did the first appellants ... seek such advice in advance of their going to Brussels in March 2001."

Lord Wilson commented that crucial paragraphs in the guidance for the taxpayers (paragraphs 2.7 to 2.9) were poorly drafted and therefore lacked the clarity required for establishing a doctrine of legitimate expectation for reliance on an interpretation of that guidance to determine residence status without further consideration of legislation or case law:

"On any view the three paragraphs were very poorly drafted. But does it follow that, when read in conjunction with the other parts of the booklet to which I have drawn attention, they amounted to a clear representation of the types for which the appellants respectively contend? Regrettable though it would be, a confusing presentation would be likely to have lacked the clarity required by the doctrine of legitimate expectation."

Standing back from detailed sections of the guidance Lord Wilson concluded that the guidance indicated that the general requirement for demonstrating non-UK residence meant that a distinct break from the UK was required, although he did moderate the judgement of. Judge Moses at the Court of Appeal:

"It is therefore clear that, whether in order to become non-resident in the UK or whether at any rate to avoid being deemed by the statutory provision still to be resident in the UK, the ordinary law requires the UK resident to effect a distinct break in the pattern of his life in the UK. The requirement of a distinct break mandates a multifactorial inquiry. In my view however the controversial references in the judgment of Moses LJ in the decision under appeal to the need in law for "severance of social and family ties" pitch the requirement, at any rate by implication, at too high a level. The distinct break relates to the pattern of the taxpayer's life in the UK and no doubt it encompasses a substantial loosening of social and family ties; but the allowance, to which I will refer, of limited visits to the UK on the part of the taxpayer who has become nonresident, clearly foreshadows their continued existence in a loosened form. "Severance" of such ties is too strong a word in this context."

Lord Wilson also concluded that the evidence provided by the taxpayers that HMRC had a practice of applying specific sectors of the guidance to determine residency such as the day count measures and certain features of overseas connection in isolation, were not strong enough to demonstrate a departure from settled practice:

"It is an arresting proposition that, having published and regularly revised a booklet in which it purported to explain how it would determine claims by individuals to have become non-resident and of which it encouraged widespread use, the Revenue departed from it as a matter of settled practice. Clear evidence would be necessary in order to make the proposition good. But there is another reason for the need for clear evidence in this connection. For, whereas, in the booklet the Revenue gave unqualified assurances about its treatment of claims to non-residence which, if dishonoured, would readily have fallen for enforcement under the doctrine of legitimate expectation, it is more difficult for the appellants to elevate a practice into an assurance to taxpayers from which it would be abusive for the Revenue to resile and to which under the doctrine it should therefore be held. "[T]he promise or practice...must constitute a specific undertaking, directed at a particular individual or group, by which the relevant policy's continuance is assured": R (Bhatt Murphy) v The Independent Assessor [2008] EWCA Civ 755, per Laws LJ at [43]. The result is that the appellants need evidence that the practice was so unambiguous, so widespread, so well-established and so well-recognised as to carry within it a commitment to a group of taxpayers including themselves of treatment in accordance with it."

Lords Walker, Hope and Clarke agreed with Lord Wilson's summary. The dissenting judge, Lord Mance, disagreed and his view of IR20 was that it did not support any requirement for a distinct break. He felt that when reading paragraphs 2.5 to 2.9 of IR20, having to assume that a "distinct break" was required seemed remarkable if it was indeed such an important factor. However he declined to express an opinion on whether the taxpayers could show HMRC had demonstrated a clear and unequivocal practice in their assessment of an individual's residence status prior to 2005.

Legislation on a statutory residence test is expected in Finance Bill 2012, and it is to be hoped that this will bring greater certainty to the issue of an individual's UK residence status for tax.

1.3. CGT private residence relief

In the case of Mr A J Clarke v Revenue & Customs (TC01461), the First Tier Tribunal considered whether two properties disposed of qualified for relief for Principal Private Residence Relief.

Mr Clarke was married with two daughters and lived at the matrimonial home Oaks Farm. Evidence was given that Mrs Clarke was having an affair. Mr Clarke purchased 60 Nayland Road in July 2002 and moved in immediately. The purchase was funded by a 12 month business loan as this was the fastest and cheapest route. Mrs Clarke refused to sell the former matrimonial home. Mr Clarke obtained planning permission to build a detached property in the garden. He subsequently sold 60 Nayland Road in March 2003 and moved into his mother's home whilst he built the new property 58a Nayland Road. He moved into 58a in July 2003. In July 2005 Mrs Clarke attempted to commit suicide and Mr Clarke moved back to the matrimonial home to protect his children. 58a Nayland Road was sold in November 2005.

HMRC contended that at no time in the period of ownership was either of the properties the taxpayer's only or main residence and there was no intention to live permanently in either of them. HMRC noted that the property purchase had been funded by a 12 month business loan and there was no evidence of correspondence being sent to either of the addresses nor had HMRC been informed of a change of address.

Evidence was submitted on behalf of Mr Clarke to support the fact that he had left the matrimonial home permanently. HMRC had accepted that he had resided at the properties so the point at issue was regarding the intention to remain with a degree of permanence at these properties.

As regards change of address, the business operated by Mr Clarke was operated from a barn behind the matrimonial home and post would be delivered there even if addressed to the main house.

The FTT found that there were compelling personal family reasons necessitating Mr Clarke to move away from the matrimonial home, and the need for find fast financing offered by the short term bank loan, and then for his later return. It also found that the moves into each of the other properties had been intended to be permanent, with the reasons given for the sequence of events being credible, so the Appellant was entitled to Principal Private Residence Relief in respect of the two properties.

2. PAYE and Employment matters

2.1. Talentcore and employment status of agency staff

The Upper Tribunal has confirmed the earlier First Tier Tribunal decision for the taxpayer (TalentCore Ltd) that its consultants were not employed under the agency rules. The agency rules operate where a worker is under contract with the agency to provide services under the terms of that contract, and where the remuneration under the contract would not otherwise be employment income. The rules apply two tests to consider whether the consultant:

(a) is acting under a contract that requires him/her to provide personal service; and

(b) is subject to a right of control by someone else as to how the service is provided.

Only if both tests are satisfied do the agency rules apply to deem the consultant to be employed for PAYE and NIC purposes.

HMRC had contended that Talentcore were required to operate PAYE on payments to cosmetic consultants operating as agency staff, who were selected from a database to work as temporary staff for airport duty-free shops and who were booked for a morning or afternoon shift.

The First Tier Tribunal had determined the consultants were not employees as there was no personal service (because there was an unfettered right of substitution). However they had concluded that Talentcore's client had a right of supervision over the consultants, even though this was rarely (if ever) exercised. The Upper Tribunal confirmed the FTT's conclusions.

This case provides a useful reminder of how contract terms can have a significant impact on PAYE and NIC obligations. If it is possible to structure the contracts so that either or both of the conditions (personal service and supervision) are not met, then PAYE and NIC obligations can be avoided. This could affect those agencies providing skilled staff (who may require no supervision assuming they have been properly vetted), and those providing either skilled or unskilled staff where it is practical to have a clause in the contract providing that the worker will organise a suitable substitute if they are unable (for whatever reason) to fulfill the contract. Such arrangements may be possible in sectors ranging from IT consulting, to tutoring and the provision of manual labour such as cleaners or builders.

3. Business tax

3.1. Efficient winding up of a company

Extra Statutory Concession (ESC) C16 indicates that where certain assurances are given to an inspector, HMRC is prepared to regard a distribution made on company dissolution (on a voluntary striking off application made by the company) as having been made under a formal winding up, thereby attracting capital treatment rather than income treatment. Currently there is no financial limit to the application of ESC C16.

HMRC recently considered legislating this concession but with a £4,000 net assets limit to its application (see Tax Update 3 May 2011). The OTS has also issued a discussion paper on facilitating the disincorporation of small companies. However for the present ESC C16 remains without amendment.

ESC C16 refers to Companies Act 1985 s652A which provided that, in certain circumstances, a private company may apply to the registrar to be struck off the register. This was incorporated in Companies Act 2006 s1003, but without the limitation to private companies.

Where a company is dissolved while still holding property, that property passes to the Crown (under Bona Vacantia). Companies Act 1985 s656 provided that the Crown's title to the property of a company on dissolution may be disclaimed by means of a notice signed by the Crown representative, but must generally be executed within 12 months of the date on which vesting of the property came to the notice of the Crown representative or within three years of the Crown representative receiving an application from an interested party. This was incorporated in Companies Act 2006 s1013, but the new provision extended the 12-month period to three years, and provides that, if the ownership of the property is not established when the Crown representative first has notice that the property may have vested, that period runs from the end of the period reasonably necessary for the Crown representative to establish ownership. Section 656 of the 1985 Act also provided that a disclaimer may be made within three years of the Crown representative receiving an application from an interested party. Section 1013 of the 1006 Act changed this to 12 months.

The £4,000 limit proposed in consultation for incorporation in a legislated version of ESC C16 may have come from the Treasury Solicitor's office guidance on how they would pursue the Crown's claim under Bona Vacantia. This guidance indicated that it would be unreasonable for the Treasury Solicitor to expect that a company is put into formal liquidation when that would be uneconomic, especially bearing in mind that ESC C16 permits a distribution for tax purposes without the company having to incur the costs of a formal liquidation. It was agreed with HM Treasury that if:

  • a company has been struck off under Section 652A of the Companies Act 1985 or Section 1003 of the Companies Act 2006, and;
  • the shareholders have taken advantage of the extra statutory concession C16, and;
  • the amount of the distribution is £4,000 or less, then as a concession the Treasury Solicitor will waive the Crown's right to any funds, which were distributed to the former members prior to dissolution.

This concession has been withdrawn with effect from 14 October 2011.


Under Companies Act 2006 it is now easier to reduce share capital (see in particular Companies Act 2006 s641, where this is possible for a private company by special resolution supported by a directors' statement of solvency) and to restore a company to the register (see Companies Act 2006 s1024 onwards). Accordingly, the Treasury Solicitor Department considers its concession ('TSC') in this area is less relevant and has therefore withdrawn it.

The Treasury Solicitor's office has indicated that their TSC and HMRC's ESC C16 concession have always been completely separate, and the removal of their guidelines and the TSC will have no effect on the ESC C16 or any other law or regulation on share capital distribution.

In assessing the most cost effective means of dissolving a company, therefore consideration should be given to:

  • the quantum of the company's net assets;
  • the likelihood of any claim under bona vacantia and whether an application for disclaimer of the Crown's interest should be made;
  • the available procedures for a company to formally approve a capital reduction;
  • the cost of undertaking a formal liquidation.

In practice the Treasury Solicitor is not required as a matter of strict law to assert a claim to property that is, or may be, bona vacantia. He would generally do so, but circumstances may arise in which it is proper for him not to assert a claim. For example, where the title to such property is doubtful, or where the costs of asserting title would exceed the value of the asset, the Treasury Solicitor may decide that it is not expedient to assert a claim. We understand that the exercise of a power of disclaimer is only done in limited circumstances, namely where the asset is either onerous, of such limited value that it would not be cost effective to attempt to dispose of it, or where the likely costs of disposal are expected to exceed the proceeds of sale.

As noted above, winding up a private company is much easier procedurally nowadays. Thus an informal winding up might proceed by working to reduce the company's net assets to a very low level. This could be done by reducing share capital and making a distribution using the procedure under CA2006 s641. Another alternative would be to effect a purchase of own shares and, assuming the purchase falls within the conditions in CTA10 s1033 (e.g. the redemption is made mainly for the benefit of the company's trade and does not form part of a scheme with a tax avoidance purpose) obtain capital treatment for the repurchase. An advance clearance for tax purposes is possible under CTA10 s1044/1045.

Once the company's assets were reduced to a very minimal amount, there would seem little risk of the Crown applying its bona vacantia rights, as there would be so little left in the company and pursuing the assets would not be worthwhile for the Crown. In applying for a disclaimer from the Treasury Solicitors office (now done on form BVC14) an initial fee of £69 is due to the Treasury Solicitors office. Obtaining the waiver would provide certainty that the Crown's bona vacantia rights would not be exercised

3.2. Subjecting goods to a process

Although industrial building allowances have been withdrawn with effect for expenditure incurred on or after 1 April (incorporated businesses) or 6 April (unincorporated businesses) 2011, and for claims in respect of accounting periods beginning on or after these dates, the issue of whether goods have been subjected to a process may continue to be relevant in determining whether an activity is a manufacturing activity if the Government decides to focus tax incentives on this sector.

A recent First Tier Tribunal case considered the matter of subjecting goods to a process in Farnell Electronic Components Ltd where it was held that repackaging electronic components into smaller packaging for distribution to other group companies was not the subjecting of goods to a process. Consequently the building in which this activity was carried out did not constitute an industrial building for capital allowance purposes.

3.3. Scheme to generate corporate capital losses

The First Tier Tribunal considered an appeal by Land Securities plc regarding a £200m capital loss generated (so Land Securities plc contended) by the operation of TCGA s106 specifying the matching rules for corporation tax where shares were disposed of and acquired within a six month period.

The background was that Land Securities was considering acquiring investment properties and sought finance provided by Morgan Stanley using a tax scheme. Land Securities had owned the nine issued shares in a company LM Property Investments Ltd, (LPMI) for a number of years (at an original cost of £9). Rights attaching to 41 of the authorised but unissued shares were changed and they were renamed "B" ordinary shares. The rights were to dividends and distributions in relation to, their capital, any premium at which they were issued, and also to any capital contribution specifically made in respect of them. A Land Securities company (Ravenscroft Properties Limited (RPL) subscribed £3.75m for the 41 B shares, while Land Securities contributed further capital of £1.25m for the 9 unclassified shares.

Land Securities (RPI) then sold its 9 shares to a Morgan Stanley Cayman Isles company, Morgan Stanley Canmore Limited ("Canmore") on 31 March 2003 (for £1.25m), simultaneously granting Canmore a put option for £1 to put the shares back on to RPI at any time within the next 12 months at market value. The expectation was that Canmore, having acquired the 9 shares, would make a capital contribution of £200 million to LMPI. LMPI would then ostensibly rank as a joint venture property investment company between RPL and Canmore, with each shareholder having rights to appoint equal numbers of directors.

The scheme was designed, from a tax point of view, to exploit the point, under TCGA s106 (this section was withdrawn with effect for transactions on or after 5 December 2005), that if (as in fact occurred) Land Securities re-acquired the 9 shares within the six-month period after their disposal to Canmore, the Appellant would be required to match its 31 March 2003 disposal of the 9 shares for just £1.25 million, not with its historic acquisition cost of £9, but with the price paid on the re-acquisition. Since by that time the value of the 9 shares had been enhanced by the capital contribution made by Canmore, such that the re-purchase price was £202,265,179 (in September 2003), Land Securities claimed a capital loss of the excess of that amount over the figure of £1.25 million. The scheme contained various commercial factors, which were 'demolished' during cross examination as not having any real effect or purpose for the transactions.

As the operation of TCGA s106 was mechanical and targeted what might otherwise be regarded as artificial 'bed and breakfasting' transactions to create a loss, the Tribunal concluded it was impossible to ignore the reality of any steps included in the series of transactions (thus a Ramsay approach to defeating the scheme was deemed to be ineffective).

HMRC then sought to apply TCGA s30 (9) to contend that an adjustment was required by that section because the disposal preceded the acquisition. However the Tribunal determined that the correct method of applying s30(9), so that an adjustment was required to the later acquisition cost (the acquisition cost in September 2003) was by first considering s106(5)(b) so that the disposal should be matched, in the case of available shares acquired after the disposal, with those acquired earlier rather than those acquired later. They thus concluded that as a result of the combined application of section 106 and sub-section 30(9) TCGA, the loss realised by Land Securities in its accounting period ended 31 March 2003 should be reduced to nil.

However there was some discussion as to how s30 (and in particular s30(9)) applied in conjunction with s106. On interpretation was that s30(9) if applicable, could be read as requiring an adjustment to the cost price of the shares acquired after the disposal. Land Securities maintained that s30(9) could not be read as referring to anything other than the acquisition of the shares actually disposed, and that as the wording of that section was specific, it must refer to the original acquisition cost. HMRC maintained that the text was more general (it refers to 'a case' rather than specific circumstances of an acquisition). The Tribunal agreed with Land Securities, that s30(9) did refer to a specific acquisition, but by virtue of s106(5)(b) was to be applied to those shares acquired after the disposal, so that s30(9) was targeted at adjusting the cost of the September 2003 acquisition where all the planning was directed at generating a large, unrealistic and contentious loss.

The Tribunal thus concluded that as a result of the combined application of section 106 and sub-section 30(9) TCGA, the loss realised by Land Securities in its accounting period ended 31 March 2003 should be reduced to nil. TCGA s30 was amended in Finance Act 2011, and this case considered the legislation in force prior to these changes.

3.4. M&S and cross border loss relief

The Court of Appeal has heard the appeal against the Upper Tribunal's June 2010 decision in M&S cross border group loss relief case (see Tax Update 28 June 2010 for a summary of the Upper Tribunal's decision).

HMRC appealed on four points (the points below except (iv)), related to the interpretation of the ECJ's decision and what they saw as a means of claiming loss relief which effectively allowed the taxpayer to choose the country in which loss relief could be claimed. They also appealed the method of calculation, holding that it was not appropriate for a German loss recomputed under UK rules to generate earlier or greater relief than under German rules due to timing differences between German and UK tax computation rules.

M&S appealed on the question of whether the losses related to pay and file years should be permitted to be relieved cross border as the ECJ's decision on this issue was made after the deadline for claiming loss relief for those years. The specific questions referred were:

i) Is the test that the ECJ established to identify those circumstances in which it would be unlawful to preclude cross-border relief for losses, the "no possibilities" test, to be applied (as the Revenue contend) at the end of accounting period in which the losses crystallised rather than (as M&S contends) the date of claim? This question involves deciding whether the Court of Appeal in the First Appeal reached a binding decision on that issue and whether it remains binding on this court in light of subsequent decisions of the ECJ.

ii) Can sequential/cumulative claims be made (as M&S contends) by the same company for the same losses of the same surrendering company in respect of the same accounting period? HMRC asserts that that is not a question decided by the Court of Appeal and is precluded both by UK fiscal rules and by the underlying jurisprudence of the ECJ.

iii) If a surrendering company has some losses which it has or can utilise and others which it cannot, does the no possibilities test (as HMRC contend) preclude transfer of that proportion of the losses which it has no possibility of using?

iv) Does the principle of effectiveness require M&S to be allowed to make fresh 'pay and file' claims now that the ECJ has identified the circumstances in which losses may be transferred cross-border, when at the time M&S made those claims there was no means of foreseeing the test established by the court.

v) What is the correct method of calculating the losses available to be transferred?

The Court of Appeal reconfirmed the decision of the Upper Tribunal (determining in favour of HMRC on question (iv) and in favour of M&S on all other questions). In introducing the case, Lord Justice Moses chose not to repeat facts other than as required for the decision on the basis there would be no new readers but that they would have grown old in their pursuit of finality. A summary of the conclusions was:

The HMRC contention in the earlier case of M&S v Halsey (see [2007] EWCA Civ 117 and ECJ case C- 446/03) that the "no possibilities" test be based on specific facts in each case rather than principles, made it difficult for HMRC to overturn a previous precedent by adopting the contrary argument in this case. Even considering the principles based argument (that permitting group relief claims to be treated as made at the time when they were actually made as permitted by UK legislation, rather than when first made – therefore permitting a situation where a claim for group relief could be made when a company had ceased trading and was being wound up), and recent ECJ case law, the Court of Appeal considered the ECJ had not departed from their original decision in M&S v Halsey. The ECJ cases considered were Oy AA ([2008] STC991) and Lidl Belgium Gmbh (Case C-414/06[2008]). While both these cases emphasised the danger of giving companies the right to elect in which Member State to have their losses relieved, the Court of Appeal concluded that in Oy AA there was no hint that the ECJ purported to do more than apply the principles previously expressed in M&S v Halsey and in Lidl Belgium Gmbh it was not impermissible for German law to prohibit relief for the losses of a permanent establishment in another Member State in order to preserve the allocation of power to impose taxes between the two Member States. The conclusion was therefore that the Court of Appeal was bound by the earlier decision in M&S v Halsey to determine that the "no possibilities" test be met at the time of claim (at the time of the operative group relief claim) rather than the time of crystallisation of losses (immediately after the end of the accounting period in which the loss was incurred).

  • In relation to successive claims, the Court of Appeal agreed with the Upper Tribunal that FA98 Sch18 para 69(2) should be ignored so that the right to cross border loss relief is not rendered "practically impossible or excessively difficult" by its strict application. The Court concluded that as a claim for group loss relief could be delayed until the end of the time limit for making a claim, there was no reason not to permit a series of claims to be made within that time limit.
  • The Court of Appeal considered that the fact that a small amount of the loss in one country could be relieved against profits arising in liquidation in another country did not mean the "no possibilities" test was failed at the time of a group relief claim made for the substantive use of the loss.
  • While the time limit for making group relief claims for those years under pay and file ran out before the ECJ's decision was determined, the Court concluded that as an EU principle is designed to confirm a right under EU law, and not to create one, where the domestic legislation precluded such a claim and the time limit imposed was not unfairly introduced, the pay and file years could not be reopened to permit a group relief claim to be made.
  • On the calculation method, the Court of Appeal held that method E (recomputing the foreign loss and any non-allowable amount using UK computational rules and timing) did in fact give effect to the losses to no greater extent than would be allowed if the subsidiary had been resident in the UK, despite the fact that the timing of the loss relief might be different between the UK and Germany.

Due to the significance of the issues for HMRC it is likely the case will be appealed to the Supreme Court, but for the present it may be appropriate for companies to review their group relief and enquiry closure procedures to ensure they are operated in the most effective manner.

3.5. Updates to HMRC capital gains manual

  • HMRC updated its corporate capital gains guidance on 14 October at page CG53175 to take account of Finance Act 2011 changes to degrouping charges.
  • CG53175 - Substantial shareholdings exemption: the exemptions available - anti-avoidance measure to prevent inappropriate exemption - identification and handling of cases
  • Paragraph 5 Schedule 7AC TCGA 1992 is an anti-avoidance measure to prevent exploitation of the substantial shareholdings exemptions.
  • It will be unusual for the anti-avoidance rule to apply. If you think it could apply so a gain on a disposal may not be exempt you should establish all the relevant facts and consider them in the light of the guidance in CG53180. If when you have done this you think you have a good case for invoking the anti-avoidance rules, you must send a summary of the facts and your arguments with all your papers to Capital Gains Technical Group. You have to obtain the approval of CGTG before you put any arguments to the effect that the anti-avoidance rule applies to the company or its advisers.
  • Statement of Practice 5/02 was issued when the rule was introduced, see CG53185.
  • Application following changes to the degrouping charge in 2011
  • FA11 introduced changes to the way the degrouping charge operates which are largely aimed at improving the interaction with the Substantial Shareholdings Exemption. These changes were introduced to make the exemption more effective for groups that make commercial disposals of trading companies. Where there is no such disposal, for example where the share disposal is to a connected party in order to avoid tax on a sale of an asset (because of the uplift in base cost) then the anti-avoidance rule in TCGA92/Sch7AC/para5 may apply so that the gain on shares will not be exempt. In terms of the legislation that is explained at CG53180:
  • A degrouping charge that is added to share consideration on a disposal that would be within the exemption (but for the anti-avoidance rule) is an untaxed gain, and;
  • Transferring assets into a group company so that a degrouping charge will arise will amount to a "significant change of trading activities" for that company.

3.6. Non discrimination article in UK/US double tax treaty and group relief between UK subsidiaries

HMRC have lost their appeal to the Upper Tier Tribunal against the First Tier Tribunal decision in the case of FCE Bank plc's claim for group loss relief by way of the US/UK treaty non-discrimination clause (the First Tier Tribunal decision was covered in Tax Update 19 April 2010).

Group relief in now available between two UK resident subsidiaries of a common parent even if the parent is resident in the USA. However, before 2000, it was not possible to establish the group relationship for group relief purposes through an overseas parent.

HMRC cited Boake Allen ([2007] UKHL 25) as supporting their position that the US residence of the parent was not the only reason for refusal of group relief. In that case the non-discrimination article of the US treaty was held to have no effect to permit a group income election in respect of ACT, but the Upper Tribunal considered this was because the overseas parent could never be liable to ACT and so ICTA s247 could have no application, and so no relevance for the FCE case. HMRC's other argument was that the real reason for discrimination was because the UK subsidiaries did not have a UK parent, not the fact that they had a US parent, and therefore the UK/USA treaty non-discrimination article did not apply. The Upper Tribunal considered this argument to be a disguised tautology, and was another way of saying the reason for refusal of the relief was the US residence of the parent.

4. VAT

4.1. Bad debt VAT relief and entitlement to adjustment of output VAT under SI1995/2518 Reg 28

There are particular rules around recovery of VAT where an invoice remains unpaid and the rules are different depending on whether the amount is determined as a bad debt, or an adjustment of the invoice originally supplied. The First Tier Tribunal considered the points in detail in a dispute between HMRC and Cumbria County Council.

As background to the VAT recovery issues for supplies made on or after 1 January 2003:

  • A purchaser must reverse any input VAT he has reclaimed where the purchase invoice remains outstanding for the later of 6 months after (i) the date of the supply or (ii) the due date for payment (SI1995/2518 regs 172G – 172J).
  • If a sales invoice remains unpaid and is treated as a bad debt, the supplier has four years and six months (previously 3 years and six months) from the later of (i) the date the consideration is written off as a bad debt and (ii) the date of supply, to claim a reduction in output VAT as a result of the write off. There is no longer a requirement to notify the customer of the bad debt write off for supplies made on or after 1 January 2003 (SI1995/2518 Regs 165A-166A).
  • If the amount of an invoice is adjusted subsequent to the accounting period in which the supply took place, an adjustment shall be made to the VAT account in the prescribed accounting period in which the adjustment is given effect in the business accounts (SI1995/2518 reg 38). Where this results in a claim for credit in respect of overpaid VAT (which can either be by way of processing a credit note, or by making a voluntary disclosure), the claim has to be made within 4 years (previously 3 years) of the end of the accounting period in which the disclosure of overpayment was made. (VATA s80 (4ZA) (b)).

Cumbria County Council's (CCC) contract service division provided emergency services to DEFRA during the foot and mouth outbreak between March and November 2001. There was an understanding by CCC that contract terms had been agreed and VAT invoices were issued in accordance with their understanding amounting to £5.5m excluding VAT. A significant portion remained outstanding (with accrued interest) for some time and the amount due was disputed by DEFRA. A settlement was eventually reached through mediation (after an application to the High Court) in March 2007, so that it was agreed DEFRA did not have to pay for invoices with a net of VAT amount of £1.1m.

HMRC refused to make a repayment of VAT under bad debt relief on submission of a voluntary disclosure by CCC on the basis that the bad debt relief claim was outside the time limit. CCC then asked in July 2009 for a reconsideration of the reclaim as a regulation 38 claim for refund of overpaid VAT. HMRC refused the adjustment on the basis that as the dispute between CCC and DEFRA had been settled and the balance due under the settlement (£200,000) had been described as inclusive of VAT, consideration had not been reduced and regulation 38 did not apply.

The Tribunal agreed with HMRC that the time limit for a bad debt relief claim did not run from the time of settlement, because if the settlement meant the amount due had been agreed, there was no bad debt. HMRC had previously described the regulation 38 claim by CCC as 'factitious' (contrived or artificial) as no trader would accept £200,000 in settlement of a claim worth some £1.4 million. However the Tribunal was of the opinion that this comment was wholly unjustified when made without evidence. They concluded that as CCC had originally issued invoices based on what, in the circumstances, was considered to be a reasonable understanding of the contractual arrangements, and as the settlement was arrived at by genuine negotiation, the declaration of VAT on the unpaid amount was an "inadvertent overpayment" of tax on invoices not due and therefore not based on any 'consideration'. They therefore determined that CCC's consideration was reduced and that this fell squarely within a regulation 38 claim.

This may be a useful reminder to reconsider the VAT recovery issues of amounts long outstanding and VAT bad debt, output tax and input tax recovery procedures.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Richard Mannion
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